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Sun: Out From Behind The Clouds


Tech industry mavens had their doubts about Jonathan I. Schwartz when he was promoted to chief executive of Sun Microsystems Inc. (SUNW) in April, replacing longtime CEO Scott McNealy. There was the ponytail, which helps Schwartz look a lot younger than his 40 years. He also has a brash style that seemed to be out of sync with Sun's grim realities. Did this Web 2.0 CEO have enough gravitas to run a struggling computer company?

It didn't take long for Schwartz to show his stuff. Sun, which had fallen far from its perch as one of the highfliers of the dot-com era, has emerged from a five-year funk to turn in two strong quarters of revenue growth and market share gains. The stock has shot up 38% since late July, and Schwartz looked golden while making the rounds of Wall Street and New York customers in early September. "We think Sun is on the way to turning around," says analyst Ben Reitzes of UBS (UBS), who recently upgraded the stock.

Schwartz is working hard to convince outsiders that Sun has shifted its core competency. His message: Sun isn't just about fast servers anymore. Now it emphasizes technology that saves customers money on electricity and yields more processing power for the buck. Schwartz wants to capitalize on the growth of consumer-driven markets, such as retail banks, telecom companies, and big Internet companies. "They're betting on the Internet to drive growth in their business," he says. "If you bet on the right customers, like we are, you can grow much faster than the marketplace." It helps that Sun has refreshed all of its major product lines in the past year.

Customers like the new computers because they're cheaper and help them pack more power into crowded data centers. Joyent Inc., a seller of e-mail and storage services delivered to customers over the Net, switched from Dell servers to Sun machines last year. When all factors were taken into account, the Sun computers were no more expensive and, over time, allowed Joyent to save money. "We had been conditioned to think of Sun as the high-priced alternative, but it's not," says Joyent Chief Executive David P. Young.

Sun's turnaround is far from a done deal, though. While revenues grew 29% last quarter, the company is still losing a pile of money. Its $301 million net loss in the fourth fiscal quarter ended June 30 included $228 million in restructuring charges. And while Sun's share of the computer server market increased to 12.9% in those three months, it's still below a peak of 16.7% in 2000, says market researcher IDC. "I don't see this as sustainable," says David V. Gelardi, a vice-president at IBM (IBM), which leads server sales with a 31% share. For one thing, Sun barely shows up in the hot market for so-called blade servers, densely packed machines that are increasingly popular in large corporations.

MORE R&D

Much of Sun's growth has come in inexpensive servers powered by Advanced Micro Devices' (AMD) Opteron chip. It's a low-margin business. Sun's challenge is to keep up the high level of investment needed to fund development of its own chips and high-performance servers. The company spent $2.05 billion on research and development last fiscal year, or 15.5% of revenues. Dell spends just 1% on R&D. Analysts say Sun will have to rev up software sales to strengthen margins.

One indicator to watch is how customers warm to Sun's Solaris operating system. It distributes an open-source version to try to win converts, and Schwartz reports that 70% of the free software packages have been loaded on Dell, IBM, and Hewlett-Packard (HPQ) computers. If Sun can persuade those customers to buy Solaris licenses and, ultimately, switch to its hardware, a sustainable renaissance may be on the way.

By Steve Hamm


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