News Analysis April 6, 2009, 8:54AM EST

After IBM, What Now for Sun?

The decision to end takeover talks with IBM leaves Sun Microsystems and its CEO, Jonathan Schwartz, with a complex problem

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Now that merger talks between IBM (IBM) and Sun Microsystems (JAVA) have broken off, the future of Sun, long one of the tech industry's most innovative and dynamic companies, is in doubt.

The breakdown puts Sun in an extremely weak position, and analysts expect its stock price to come under severe pressure. The stock had been trading at about $4 a share, but rose to above $8 when word of the IBM talks leaked in late March. "Sun is now sort of damaged goods," says Peter Falvey, a partner at Boston-based Revolution Partners, which invests in Silicon Valley firms. "If IBM got under the covers and didn't like what they saw, then what does that mean for other potential buyers?"

Only a couple of companies stand out as potential acquirers. Cisco Systems (CSCO), the networking giant, recently got into the computer server business, and Oracle (ORCL), the world's No. 2 software maker, has long been a close partner with Sun, which specializes in making the kind of servers large companies use to run Oracle database software. But neither of those organizations is a natural fit, since they're not computer companies, per se. The two largest computer makers, Hewlett-Packard (HPQ) and Dell (DELL), are very unlikely to show interest in Sun. Both are committed to selling so-called industry-standard servers that run on microprocessors made by Intel (INTC) and Advanced Micro Devices (AMD).

Sun Sought Assurance of IBM's Commitment

IBM and Sun had been talking for more than three months, but a disagreement over price and some terms of the agreement led to the break-off, according to people close to the negotiations. Neither IBM nor Sun would comment or even acknowledge that they had been negotiating. Toni Sacconaghi, an analyst at Bernstein Research, says: "I am worried that Sun's customers won't continue to hang in [in] uncertainty, wondering if Sun will be an independent company and whether all its technologies and platforms will be supported. Clearly, this could have a material impact on business going forward."

Earlier, the companies had been talking about a price in the $10- to $11-per-share range, which valued Sun above $7 billion. But IBM pressed for a lower price, and on Apr. 4, Sun insisted on the higher one. Sun also wanted assurances that IBM would remain committed to the deal even if it ran into serious objections from government antitrust authorities, according to the sources.

The deal would have faced intense antitrust scrutiny and been one of the first major test cases for the Obama Administration in signaling its posture toward antitrust policy. Through the combination, IBM would have had a monopoly-strength position, with 65% of the market for server computers based on the Unix operating system. However, IBM does not have anything near monopoly power when the entire computer server market is taken into account. A Sun acquisition would have increased its share of the market by nearly 10%, to 42%, but it faces fierce competition from the world's two leading computer companies, Hewlett-Packard and Dell.