Oracle, With Sun Micro Buy, Steps Into Ring With IBM, H-P

Oracle Corp.'s (ORCL) unexpected $7.4 billion agreement to buy Sun Microsystems Inc. (JAVA) launches the software giant into a ring already featuring tech heavyweights International Business Machines Corp. (IBM) and Hewlett-Packard Co. (HPQ).

The purchase would enable Oracle to offer a complete package of information technology products for all of businesses' tech needs. At the same time, though, getting into the hardware business could irritate long-standing partnerships, hurt Oracle's margins and test management's ability to fight an uphill struggle in an industry other than software.

For those reasons, some think Chief Executive Larry Ellison may not keep Oracle in the server game. "I don't think Ellison wants to be in the hardware business," Bob Gill, an analyst with TheInfoPro, said. "The hardware business is lower-margin."

On the software side, Sun delivers a number of attractive assets, such as Java, the Solaris server operating system and MySQL open-source database - assets that Oracle may not have wanted to let slip into rivals' hands.

"We are positive that Oracle never wanted to get into the hardware business but when faced with the likelihood of IBM owning Sun's Java assets and the company's installed customer base, Oracle was forced to buy Sun," said Peter Goldmacher, an analyst with Cowen & Co.

For its part, Oracle sounds committed and excited by the merger's prospects. "Oracle is now able to make all of the pieces of the technology stack," Ellison said on a conference call Monday.

Dana Gardner, principal analyst at Interarbor Solutions, said the combination of Sun's hardware and operating systems with Oracle's business software and sales force creates a powerhouse that has the clout to serve as a global counterweight to IBM.

"This was a tectonic shift," he said.

Gardner said that while Sun had developed a line of commodity servers to complement its high-end boxes, it lacked the software and sales force to break into new accounts. Those products will now be pushed by Oracle's disciplined sales force as part of the company's integrated solutions, a strategy that could allow Oracle to secure higher hardware margins than Sun was able to do.

"This is Oracle climbing in the ring with IBM and H-P," said Martin Reynolds, vice president at Gartner. "Enterprise IT is going to consolidate, and (Ellison) is just taking his share of it."

Reynolds said the deal raises questions about whether Oracle might take additional steps to build or acquire a services arm that will rival IBM's global consulting business.

The move also enhances Oracle's presence in cloud computing, the term for performing computer functions off site; Ellison has yet to embrace the concept.

"You'll see Oracle get to move from the passenger to the driver seat in cloud computing," said Eric Openshaw, U.S. technology lead at Deloitte LLP.

 
   Risky Move 
 

Sun, though, also lumbers the Redwood City, Calif.-based company with a lower-margin hardware business at a challenging time for the industry. The market for corporate servers is expected to decline in 2009 compared with 2008, according to research firm IDC, and Sun's hardware products are losing market share to the lower-end servers based on Intel Corp.'s (INTC) X86 chips.

The server industry is dominated by giants IBM and H-P, with the potential of Cisco Systems Inc. (CSCO) joining soon. Oracle has limited experience selling hardware. Sun is the world's fourth largest maker of servers.

There're also concerns about the effect of mixing sales of Sun's servers, which have a low profit margin, with Oracle's much more profitable software business. Tim Klasell, with Thomas Weisel Partners, noted that Oracle's operating margins, currently around 46%, will likely fall to around 35% in the first year after the merger, although they are expected to rise later.

A Sun/Oracle tandem also could muddy many crucial business partnerships. To be sure, the world of IT hardware sales is quite tolerant of competition among companies with sales partnerships. But because of both companies' size, a duo of Sun and Oracle could create confusion among Oracle customers that major rivals could quickly capitalize on.

For instance, Kaufman Brothers analyst Shaw Wu said H-P, the world's No. 2 server seller, and No. 3 Dell Inc. (DELL) both have partnerships to sell Oracle's database software.

"Now that Oracle does servers, do they still partner?" Wu said.

Peter Falvey, co-founder of investment bank Revolution Partners, said that in IT infrastructure markets, "all these traditional lines have started to blur," forcing companies to become more diversified.

"It's a really hard market if you are just selling boxes," Falvey said.

Dell, H-P and IBM declined to comment for this story.

-By Jessica Hodgson, Dow Jones Newswires; 415-439-6455; [e-mail]

(Scott Morrison, Ben Charny and Jerry A. DiColo contributed to this report.)