Why Would Big Blue Want Sun?

Investors active in the IT sector were shocked on the morning of 3/18/09 as they awoke to news that International Business Machines (IBM) is working to make its largest acquisition ever when the offered to buy Sun Microsystems (JAVA). The important thing to consider here is whether this aligns with IBM’s overall strategy and reinforces their competitive edge over the likes of Hewlett-Packard (HPQ), Cisco (CSCO), and Oracle (ORCL). So where do I stand on this acquisition, after all, don’t acquisitions destroy shareholder value? Initially, one could say that this is a terrible move for IBM.

Who wants a company that posted a loss per share of -$2.40, and has been unable to shake off unprofitability for years? Well… IBM does, yes this maybe quite crazy, but this is a move that is very bold and opportunistic from CEO Palmisano’s perspective. Pondering the reasons why this makes sense from IBM’s perspective, I was able to draw three solid drivers for this buyout. Keep in mind that the pair have declined to comment on the details of  this possible tie up and the only information is coming from a source close to these parties. For those of you skeptical of this acquisition, I am taking sides with IBM as a shareholder who understands the consequences of acquisitions.

Retaliation to Cisco

Cisco, the leader in telecommunications technology and equipment, announced its entrance into the server market with its own line of blade units. This is direct competition to not only IBM, but also HP who are users of the switches, bridges, and other communication components that Cisco provides for server and data center configuration.

IBM has slowly divested slower growth hardware segments such as Lenovo, but I think Sun brings a solid server and workstation line that runs similar open source operating systems which IBM supports. Cisco could pose a serious threat if their servers are priced at a discount with cutting edge communication hardware that can trump those offered by IBM or HP. The reason why Cisco is still trumped in the battle is due to the fact that they have to still buy software to apply on these servers which can come from the likes of IBM, HP, Oracle, or Microsoft (MSFT) amongst others. This key concern, the lack of homegrown hardware and software leads to our next reason…to take over as #1 in the data center market.

The  Datacenter Battle

The datacenter is a complicated and difficult thing to build and maintain. It is very capital and time intensive to develop a sufficient center for one’s needs. The biggest names in business often look to the large IT names to develop and maintain their back end to keep their business up and running. It is becoming increasingly competitive to take over as a leading provider in the datacenter space.

The key here is to become vertically integrated, offering integrated hardware and software solutions for your customers. HP’s acquisition of EDS moved them closer to IBM, and now as Cisco, a component provider, brings its own blade servers, the likes of IBM must compensate. Sun’s workstations, and blade servers are great pieces of hardware to operate in an evolving cloud architecture. In addition to their servers and workstations, Sun has a solid footing in storage systems as media and software increasingly requires storage space.

Sun, a supporter of open source software and a hardware powerhouse, will fit well with IBM’s existing offerings from the slew of corporate software combos which it can offer customers with its integrated niche offerings. Sun has had trouble staying profitable, but I believe once it is acquired into IBM’s supply chain it will be leaned down and fit in well into the big blue’s business. Lets face it, customers seem to want a one stop shop and Sun can offer a host of niche products and a solid footing in hardware to help IBM be the #1 datacenter solutions provider.

Force HP on the “offensive”

It is coincidental that the same day that news of the IBM, Sun marriage came out; HP had its shareholder meeting. The CEO brushed off the news, but did note that the competitive environment is changing and that Cisco adds a new factor to the mix. IBM adds a new facet to HP’s situation as it enters the server manufacturing market with an already strong IT software and services segment.

IBM CEO Sam Palmisano did state his company is on the “offensive,” and it seems that this move pressures HP to become more “offensive” themselves. HP put the heat on IBM with its acquisition of EDS, finding a way to provide software with its inexpensive servers, but now the tables have turned as IBM. IBM is loaded with cash and is seeking to expand itself amid the plentiful market opportunities. IBM is looking to be #1 as infrastructure will require more IT datacenters and business growth. With more affordable technology, what better way to render competitors obsolete than this?

All in all, this is a good move for IBM. There are risks with any merger, but IBM can restructure Sun and absorb it as part of its extremely profitable business. I would not dump any shares just because of this deal, it has major potential to solidify IBM as #1. Cisco has just released its servers, breaking into the hardware space, and HP maybe falling asleep at the wheel. Any ideas of Cisco scooping up Sun Microsystems are half baked as Cisco does not have the track record of merging trouble companies into its existing operations. IBM is the top suitor, and as shareholders, it is important to keep on top of your news and get ready for a potentially exciting time in tech.

Disclosure: The fund the author is associated with is long IBM and CSCO. The author’s family is long IBM and MSFT.

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