Oracle Gets Approval To Buy Sun Microsystems

The largest software company, Oracle Corp. (ORCL) announced that the U.S. Department of Justice (DOJ) has approved its proposed acquisition of Sun Microsystems, Inc. (JAVA). The approval from the DOJ was much anticipated.

In June, the DOJ had extended its investigation on the deal to gather more information and further review the effects of the merger on competition for International Business Machines Corp. (IBM), Oracle’s biggest database software rival, as well as Hewlett-Packard (HPQ) and Cisco Systems Inc. (CSCO), which compete with Sun in the server market.

The clearance had earlier been delayed due to scrutiny about the licensing of Java, a programming language and software developed by Sun, which is used in IBM’s products. Moreover, issues lingered on Oracle’s potential acquisition of Sun’s MySQL - an open-source database software, which overlaps Oracle’s own database software.

Oracle had agreed to buy Sun for $7.4 billion ($9.50 a share) after IBM backed out of its deal. The transaction was valued at approximately $7.4 billion, or $5.6 billion net of Sun’s cash and debt. Sun’s stockholders and Board of Directors unanimously approved the transaction on July 16, 2009.

However, the deal is still subject to clearance by the European Commission to be convened on Sept 3 (a tentative date). This is not a cause for worry, as we expect the deal to be cleared by European regulators.

We believe one of the two major flaws is the price of the deal, which is much more than Sun’s current price in the stock market. The other is the integration of Sun, which could be a major problem for Oracle.

Sun’s performance has not been good for quite a number of quarters. Oracle will need to pay down the high debt as Sun is in a net debt position after allowing for its cash, which will definitely hurt Oracle’s profitability. Moreover, Oracle will have to sell the hardware and service part of Sun to get back some of the purchase price. This deal is a departure for Oracle from its traditional software to hardware front.

On a positive note, the acquisition of Sun will give Oracle more control over the development of Java, a key technology used in its products. Although, Sun’s unsuccessful management has failed to steer the company onto the road to profits, we would expect some executive changes at Sun, which could benefit Oracle.

We therefore maintain our neutral rating on Oracle.

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