Make or Break Time for Sun

Two years into his reign, Schwartz's turnaround strategy is being second-guessed by much of Wall Street. Will the Sun board be more patient than financial analysts?

These are turning into tough days in the executive suite at Sun Microsystems. Wall Street has begun to get impatient with the company, causing the rumor mill to do what it does so well: grind.

Take your pick of the latest gossip: the company is for sale; its storage business is for sale; the SPARC processor will be killed off; CEO Jonathan Schwartz's head is on the chopping block. The TechCrunch IT blog reports that, which once proudly boasted of being run on Sun hardware, has retired its last Sun servers in favor of Dell hardware. declined to comment on the report.

The company isn't keen on the rumors and made no bones about saying so.

"Sun is committed to its growth strategy, its leadership team and building value for its shareholders," the company said to in an e-mailed statement. "Storage is an important part of that strategy as evidenced by our Open Storage initiative, our leadership in flash, and our announcement of the world's first 1TB tape drive. Statements to the contrary are pure rumor mongering and FUD (define)."

To try and halt its bleeding, Sun (NASDAQ: JAVA) earlier this week announced that the fourth quarter would come in at projections when it reports on Aug. 1. It said the quarter's net income would be between 5 cents and 15 cents a share and full-year earnings would be between 25 cents a share to 35 cents a share. Revenue for the fourth quarter would be between $3.72 and $4 billion.

That gave the stock a temporary boost, until a bunch of Wall Street analysts said they thought otherwise. They contended that Sun didn't include restructuring charges in its numbers, which will cause it to miss estimates. Barron's collated the negative comments into one collective beatdown.

Unreasonable expectations?

But industry observers talked to think Wall Street is being unfair, given the mess Schwartz inherited in 2006. "If you look at what he was handed when he took over, I have a hard time pinning the current position of the firm on him," said Steven O'Grady of Redmonk.

"He didn't have a lot to work with when he took the reigns," O'Grady said. "Is he perfect? No, but too often executives are assigned blame for expectations that can't be met, or folks are looking for an immediate turnaround."

Josh Farina, an analyst with Technology Business Research, added, "I can't see how Schwartz can't be in trouble, but as for the company itself, he's done a good job getting them back on a growth path and has gotten profitability back."

In the two years since Schwartz took the helm from co-founder Scott McNealy, he has been nothing if not bold. He made peace with Intel and now offers Intel-powered Sun hardware. He also secured a truce with Dell and Microsoft, something not possible under his predecessor.

More shocking, Sun has made the Java language and Solaris operating system open source under a generous license, the GPL. This has won Sun a lot of new friends in the open source community.

Then Schwartz made a surprising play by acquiring open source database darling MySQL for $1 billion, a mighty generous multiple for a company with $50 million in sales.

While Sun has returned to profitability, revenue is barely moving. While IBM, HP and Dell rack up large wins, Sun crawls along with minimal year-over-year growth, and no company can afford to fall behind.

"Clearly they are not blowing people's doors off," O'Grady said. "The strategy has not been an unqualified success, but the expectations that it would be are misguided. The bets made around open source software are not bets that pay off in six quarters. They take a few years."

David Hill, principal of the Mesabi Group, concurred that patience is needed. "He inherited a real mess. It takes time to solve a problem. The mistake many people make is they react abruptly and try to make too many changes quickly," he said.

Hill added that former General Electric chairman Jack Welch needed a ten-year plan to change the culture at GE and make it the success it became.

Schwartz hardly has Yahoo CEO Jerry Yang's problems, but while he doesn't have a powerful investor and the CEO of a giant software company out to fire him, he nonetheless may be running out of time.

"It's been a couple of years -- I don't think you can wait much longer than that and say we'll give him more time," Farina said. "Something has to happen. Either he takes decisive action or investors will force them to take more decisive action."

What to do next

What that decisive action might be is open to debate. There have been rumors within the investor community that Sun is considering selling off its StorageTek unit, which it bought in 2005. But Hill thinks that would be a big mistake.

"The problem is when you sell your product, you do much better if you can sell both servers and storage," he said. "A company needs to have a full story, even if you compete with EMC and lose some business. You can't just be a server company.

"Dell realized that and acquired EqualLogic," he added. "If Sun stays only in servers, they run the risk that if they go south in that market, that's all they've got."

O'Grady thinks Sun needs to push heavily into new markets because its dominance over Internet servers, where Sun reigned supreme in the 1990s, has gone away. The company that once used to advertise that it was "the dot in dotcom" put a lot of eggs in the Internet basket and failed to grab significant presence in other industries.

"Sun's big problem is basically getting visibility and getting footprint," he said. "Infrastructure used to be built on SPARC and Solaris, but a lot of that has shifted to LAMP [Linux, Apache, MySQL, PHP]. So a lot of startup workloads that went to Sun went away.

"Larger firms had enterprise accounts to fall back on, but Sun didn't have the same breadth of enterprise accounts when the dotcom crash happened."

Farina believes Sun needs to be more aggressive in its restructuring. Schwartz resisted any layoffs strenuously before finally making the cuts, but even those have proven relatively minor, Farina said. The company also still spends $2 billion a year on R&D -- and you can't spend R&D money like you are Intel unless you have Intel's level of income, which Sun does not.

"I credit Sun for not wanting to make big changes and cut staff, but I really question it as something they need to do," he said. "That's a very altruistic kind of position to take, but that's not necessarily the best thing for the company. It's put [Schwartz] in a bad spot."

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