Why IBM Would Buy Sun Microsystems

Posted by: Steve Hamm on March 18

A potential merger of tech giants IBM and Sun Microsystems is rattling the tech industry. The Wall Street Journal reported overnight that the two companies are in merger talks and that IBM has offered $6.5 billion. There are plenty of reasons for IBM to want to buy Sun Microsystems. Even though computer hardware has steadily become a less and less important part of IBM’s business, Sun is a lot more than a hardware company. It has been one of the most important Silicon Valley innovation factories of the past two decades—much of it in software. So, when you combine IBM, the innovation leader of the east, with Sun, the innovation leader of the west, you get quite a formidable player.

Sun’s major innovations have included the Java programming language for Internet computing, the powerful Solaris operating system for server computers, and its newer technologies for inexpensive server computers that are powered by microprocessors from chipmaker AMD. The company has very strong positions in several important server markets, including telecommunications, the federal government, and Web 2.0 companies. And it has a loyal following of more than 1 million corporate software developers and 9,000 independent software makers.

Other considerations: Sun is available. It has been peddling itself to other major computer companies. And the price is right. While a $6.5 billion price tag that would make it IBM’s largest acquisition ever, the company has more than $13 billion in cash on hand and can easily afford it. An IBM spokeman wouldn’t comment on the reports.

Initial reaction from Wall Street analysts following IBM was lukewarm to the deal. Maynard UM of UBS pointed out that there’s considerable overlap in the two company’s server offerings. When trading began this morning, IBM’s shares were down 2.40 or 2.5% at $90.53; while Sun’s shares were up 3.11, or 62.58%, to 8.08.

IBM’s main challenge, if it buys Sun, will be to continue its steady march of profit margin improvements. IBM is a profit-focused company. Revenue growth is secondary for the company’s leaders and for analysts and investors. Hardware had 8% pre-tax profit margins, compared to 32% for software and 12.4% for services. So, if the Sun deal goes through, IBM’s margins will take a hit. It will be under the gun to make the deal pay off.

One of the most important things that the Sun deal would do for IBM is help it make the transition to the next step in corporate computing: the cloud computing era. IBM has long dominated as a supplier of computers and services for corporate data centers, but as more and more corporations shift to having their computing tasks done in huge, efficient data centers managed by others, IBM can’t rest on its laurels. Sun is announcing its own cloud computing strategy at an event in New York today, and it has a very strong collection of technologies—which include Solaris, low-cost servers that are powered by AMD microprocessors, and the open source MySQL database. “Ultimately, every major computer maker will have a cloud,” predicts Lew Tucker, vice-president and CTO of Sun’s cloud computing division, who spoke to BusinessWeek on Tuesday.

In the world of cloud computing, powerful and inexpensive technologies will rule the day. If IBM buys Sun, it will bolster its position in the datacenter technology business, where it competes hard with Hewlett-Packard and Dell and faces a new challenge from Cisco Systems, which on Monday entered the market for datacenter server computers.

While Sun has been very good at inventing things, it hasn’t been so successful when it comes to figuring out how to turn its innovations in revenues and profits. IBM, through its large services organization and vast sales force, is expert at packaging up technologies into service offerings that are attractive to corporate tech chieftains. So another potential advantage of this merger would IBM be channeling Sun’s technologies to market more effectively than Sun.

There’s another element of the story that shouldn’t be underestimated. This could be a defensive move. Sun’s revenue growth has been stagnant for three years, and IBM depends on Sun as an ally in the anti-Microsoft camp. Sun owns Java, is a major player in the open-source computing world, and supports open computing standards—all of which are major counterweights to Microsoft Windows and Office software monopolies. When Sun weakens, Microsoft gets stronger. Bad news for IBM.

There’s no assurance that this deal will go through. Talks could break down. It’s even possible that another bidder might emerge. Cisco and Hewlett-Packard are both possibilities. But if an IBM/Sun deal happens, this will mark a seismic shift in the tech industry.

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