IBM-Sun Deal Collapses (but should it have ever gotten this far?)

IBM withdrew its $7 billion offer for Sun Microsystems today, putting an end to several months of exclusive talks between the two companies.  Sun, a company that was a pioneer and innovator in high-end workstations and servers that, as the company’s tagline once put it, “put the dot in dot-com,” has struggled in recent years although it has retained a valuable customer base, a treasure trove of intellectual property, and a vaunted research and development staff.

IBM’s decision to withdraw its offer, which dropped from $9.55 to $9.40 per share on Saturday, may be a negotiating tactic and the two sides could theoretically resume discussions.  IBM has not spoken publicly about the possible acquisition but the move would have led to a significant consolidation in the highly-competitive server and data center market.  IBM would end up way ahead of close competitor Hewlett-Packard and would gain entry into other key markets where it has little presence, including the growing storage market, now dominated by EMC and Network Appliance, as an added bonus.

While IBM would clearly benefit from the acquisition (the company has been weathering the economic downturn just fine having seen increased profits despite a 6% decrease in revenue), Sun, on the other hand, actually needs a deal to survive in some fashion.  It’s lost almost $2 billion in the last two quarters and has laid off some 2,800 workers this year as part of a cost-cutting exercise.  Sun has been trying to convince itself, in many respects, that it was a software firm (it fancied itself going head-to-head with Microsoft after acquiring Open Office in 1999) but hardware has always been at the core of its business – and its earnings.  If IBM and Sun don’t return to the table, others may come calling.  Cisco recently entered the server market and would benefit from an instant installed base.  Sun’s customers, largely in government, financial services, and telecoms companies, are a loyal bunch and that loyalty is what has kept Sun intact to date.  Sun’s other businesses, including the Solaris operating system, Web infrastructure software, Java, MySQL, and NFS, would be icing on the cake although an acquirer might even sell or spin some of these off.

In addition, Sun would be a difficult entity for IBM to swallow considering the vast differences in corporate culture (laid-back Sun versus buttoned-down IBM) and IBM’s competitors wouldn’t hesitate to leverage any hiccups to their advantage.  Very few mergers work out as advertised; the promised efficiencies hardly ever seem to materialize (think DaimlerChrysler for a textbook example); and customers, sensing trouble ahead, look elsewhere.

The Wall Street Journal broke the news of the merger last month.  At the close of trading on Friday, Suns shares were at $8.49.

Jonathan B. Spira is the CEO and Chief Analyst at Basex.

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