Oracle Takes Over Sun

The database software giant Oracle Corp. (ORCL - Analyst Report) announced the completion of its pending acquisition of Sun Microsystems Inc. (JAVA), a provider of enterprise computing systems, software and services, for $7.4 billion ($9.50 a share) or $5.6 billion net of Sun's cash and debt. Sun has been de-listed from the Nasdaq. Sun’s CEO Jonathan Schwartz is expected to resign as the transition moves forward.
 
The acquisition has been on hold for nine months pending the European regulator’s approval as it would decrease competition in the database market. However, the regulators approved the acquisition recently after Oracle reassured them that it would support, license and develop MySQL – Sun’s open source database software.
 
Oracle laid out various strategies for new product launches and the integration of the two companies. With Sun’s acquisition, Oracle will enter the hardware market, where it plans to integrate Sun’s hardware business (the Sparc chip and the Solaris operating system) into its own database and business applications software business. This integration will open up Oracle from its traditional software business model.
 
Oracle plans to move Sun's hardware offerings onto a build-to-order model, under which it will launch new high-end systems. Further, Oracle will close down two distribution centers, one in the U.S. and the other in Europe, following the acquisition. Oracle also plans to hire 2,000 salespeople, engineers and developers, while eliminating about 1,000 Sun employees.
 
Oracle will also increase its R&D spending by $1.5 billion in 2011 to boost investment in new products. Last year, Oracle spent $2.8 billion on research, while Sun spent $1.6 billion. Oracle said that it would sell products and provide technology services directly to Sun's customers instead of relying on third-party service providers, a strategy similar to that previously followed by Sun. Oracle’s CEO has also reassured users of Sun's equipment and software regarding continued refining of Sun’s products. By adding sales staff, increasing direct sales to Sun's largest customers and increasing R&D spending, Oracle plans to make Sun Microsystems profitable.
 
The acquisition will enable Oracle to eliminate its prime competitor, Sun Microsystems, and help the company compete against International Business Machines (IBM - Analyst Report), its biggest database software rival, as well as Hewlett-Packard (HPQ - Analyst Report) and Cisco Systems (CSCO - Analyst Report). The acquisition of Sun will give Oracle more control over the development of Java, a key technology used in its products.
 
Moreover, the acquisition is expected to be accretive to Oracle’s earnings by at least 15 cents per share on a non-GAAP basis in the first full year of closing of the transaction. The acquired business will contribute over $1.5 billion to Oracle’s non-GAAP operating profit in the first year, increasing to over $2 billion in the second year. The acquisition will bring long term synergies to Oracle besides strengthening its competitive position and increasing its developer base in enterprise computing.

While Sun’s results were not showing any spark in the recent quarters with poor execution and deteriorating market share, the acquisition by Oracle will revitalize the Sparc and Solaris operating systems and strengthen the Java development platform. With the addition of servers, storage, SPARC processors, the Solaris operating system, Java, and the MySQL database to Oracle's portfolio of database, middleware and business applications, Oracle will be well positioned to grow in the database market.
 
Following the acquisition, Fitch Ratings raised Sun Microsystem's issuer default rating to “A” from “BBB-”, indicating a stable outlook.
 
While Oracle is expected to become the premier player in the database software market, ahead of IBM, we remain concerned about the company’s integration of Sun, which is something to look out for. Even if it is successful, we believe it will take years to provide incremental benefit.
 
Thus we maintain our Neutral rating on Oracle.

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