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Volume 2, Number 21 -- June 2, 2005

Sun Microsystems Buys StorageTek for $4.1 Billion

by Timothy Prickett Morgan

After pulling an all-nighter working through Wednesday and into the wee hours of Thursday morning, executives at Sun Microsystems and StorageTek abruptly announced before Wall Street opened for business that Sun would acquire StorageTek for $4.1 billion, capping a long line of storage-related acquisitions for Sun as it tries again to be a key player in the storage business. The deal brings to rest all of the chatter about what Sun might do with the billions of dollars it has in the bank.

Over the years, Sun has tried to make money in the storage business by leveraging its substantial presence in servers, and has had mixed results. In 1997, Sun bought the storage business of Encore Computer for $185 million, a deal which aimed to beef up its high-end disk arrays as the dot-com bubble was expanding. Sun had mixed results with the products that resulted from this deal, and ended up giving former partner EMC a way to compete with Sun in its own server market--not the effect that Sun was shooting for. In 1998, Sun acquired a tiny company called RedCape Policy Software for an undisclosed amount of money to beef up the policy-based management features in its StorEdge disk arrays; RedCape had created a set of Java-based tools to manage storage. In 1999, Sun bought MaxStrat, a maker of RAID disk arrays aimed at the high performance computing market; exactly where the MaxStrat technologies have been deployed is unclear. In April 2001, Sun bought HighGround Systems, a maker of storage resource management software, and a month later it acquired LSC, an obscure vendor of high-performance file systems. This all looked like it was leading somewhere, but then in August 2001, Sun just gave up on disk arrays and inked a reseller agreement with Hitachi and brought in low-end storage from Dot Hill. Still not finished, Sun in November 2002 acquired Pirus Networks, a maker of storage virtualization software, and only a few weeks ago it acquired the NAS software created by Procom Technology for $50 million in cash. Sun has been licensing Procom's software since April 2004 for use in its StorEdge 5000 series of NAS devices.

The StorageTek acquisition announced today makes all of these deals look like child's play, both in terms of the size of the deal and in the broadened scope in basic storage hardware and software that Sun will now have, as well as its new standing in the nascent information lifecycle management (ILM) market. For that $4.1 billion in cash (which works out to $3.3 billion in net cash after you take into account the dough StorageTek has in the bank), Sun gets its hands on a company that challenged IBM in its own mainframe disk market back in the 1980s, went bust, came back from the dead, and then pioneered robotic tape silos and mainframe RAID disk arrays. The tape silo business is what StorageTek is best known for, but its 9840 and 9940 tape drives (as well as earlier clones), have been competitive with IBM alternatives. When Unix started growing like crazy a decade ago, StorageTek supported its products on Unix boxes, and as Windows took off, it did the same. So while StorageTek has a strong mainframe presence--something that is attractive to Sun because it has always thought it can sell Unix boxes to disgruntled mainframe shops who are tired of the high cost of these machines--it also has a big footprint in Unix and Windows shops. The company has supported IBM's AS/400 and iSeries line with its tape products for more than a decade as well, and these products obviously, play particularly well in shops that have a mix of these platforms. Sun chairman and CEO, Scott McNealy, boasted on a conference call with Wall Street analysts today that 36 percent of the archived data in the world sits on StorageTek devices.

StorageTek had $2.2 billion in sales last year, and has been able to achieve that level by having a 1,000-person strong direct sales force and through partnerships. Because it was something of a Switzerland for server makers and because of the innovations it made in tape drives and silos, StorageTek has partnerships with most of the major players; it will be interesting to see how this plays out. Mark Canepa, who heads up Sun's Network Storage Products Group, indicated that Sun had every intention of maintaining those partnerships with OEMs and channel resellers, who account for some unknown portion (but probably a large portion) of StorageTek's product sales. One particularly interesting one is with Sun rival Hewlett-Packard, which just extended its OEM partnership with StorageTek a few weeks ago. "We expect the relationship to continue as-is," Canepa explained on the call. "I don't see any major concerns there." Wall Street probably will, and it is fair to say that HP might as well, since it certainly does not want to put profits into Sun's pockets. But, then again, StorageTek licenses technology from HP--such as LTO tape drives--and HP doesn't want to lose that business to Seagate Technology or IBM. So maybe Canepa has a point. (Interestingly, Canepa used to run HP's Unix workstation business before he jumped to Sun in October 1996. He has been running Sun's storage unit since April 2001, and has been the major force behind all of those acquisitions rattled off above.) To try to calm down analysts who kept pestering Sun and StorageTek about the OEM question, Patrick Martin, StorageTek's chairman and CEO, said that no OEM partner accounted for more than 10 percent of StorageTek's product sales. This is somewhat calming until you realize that he didn't say how many partners StorageTek has. What is calming on the OEM question is the fact that services accounted for 41 percent of the company's $2.2 billion in sales in 2004. This part of StorageTek's sales cannot be immediately affected by persnickety partners who go elsewhere for tape drives, tape silos, and storage software. Over the long haul, of course, OEMs who go elsewhere absolutely affect that services revenue stream.

Sun and StorageTek have been partners in the storage business for a decade, and McNealy said in the call that there was not a lot of overlap in the product lines between the two companies, except in midrange disk arrays, where both companies sell products based on LSI Logic components. He said that the companies' respective product lines would be merged into a single product line and that there is not going to be a huge change to product roadmaps. Canepa said that where there was overlap in midrange storage arrays, Sun would probably merge the lines and redeploy extra engineers to other projects, "since there are plenty of other things to do." Sun hopes to have the deal closed by late summer or early fall, and is obviously hoping that another company--such as Hewlett-Packard, which needs to beef up its storage sales force as much as Sun did--doesn't swoop in and offer a higher bid.

It is unclear if someone will try to outbid Sun. StorageTek had a weaker than expected first quarter in 2005, and its stock took a bit of a hit, but Wall Street has been generally happy. Last August, the company's shares were trading at around $25 a pop, and prior to the announcement by Sun, its stock was trading at just over $31 a share, giving it a market capitalization of $3.35 billion. This is almost precisely what Sun paid for StorageTek in net cash, but StorageTek was keen on trying a little misdirection on this issue. Martin said that at $37 a share, that is an 18.5 percent premium over yesterday's stock close, and he added that Sun's price of $4.1 billion "represented a full and fair value" for StorageTek and that the deal was "the right transaction with the right company at the right price at the right time." This will only be true if a spoiler doesn't try to buy StorageTek, of course.

While the StorageTek deal will help bolster Sun's top-line numbers by $2 billion or so a year, it will also perk up its bottom line a little, if StorageTek can match its 2004 numbers. StorageTek brought $191 million to the bottom line last year. Over the same four quarters in 2004, Sun had losses of $106 million on sales of $11.2 billion. How much profit Sun can wring out of the deal in its fiscal 2006 (which starts July 1) depends on how much it costs to integrate StorageTek into Sun. There does not appear to be any plans for layoffs, and Martin said a few times that StorageTek's main factory in Puerto Rico was among the top-run factories in the world and that he did not anticipate any changes to manufacturing operations there. Sun will, of course, be able to leverage the now 11,000-person Sun sales force (with 1,000 from StorageTek) to sell more StorageTek products into the Sun base and more Sun products into the StorageTek base. "We can take our megaphone out and gain some market share," McNealy said. And to make this deal worth what Sun is paying for it, that is exactly what Sun has to do.

Before the deal, Sun had $7.4 billion in cash and equivalents and $1.1 billion in debt; after the deal, it will have $4.5 billion in cash and $1.1 billion in debt. Sun has about 32,000 employees, and StorageTek has about 7,100, with 1,000 in sales, 2,000 in services, and 700 in engineering.

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Editor: Timothy Prickett Morgan
Contributing Editors: Dan Burger, Joe Hertvik, Kevin Vandever,
Shannon O'Donnell, Victor Rozek, Hesh Wiener, Alex Woodie
Publisher and Advertising Director: Jenny Thomas
Advertising Sales Representative: Kim Reed
Contact the Editors: To contact anyone on the IT Jungle Team
Go to our contacts page and send us a message.


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