April 2009


Sun’s Fiscal 3Q09 results raise further questions about Oracle’s lofty $1.5B operating profit target for Sun in year 1.

Sun’s revenue came in at $2.61B, down 20% yty from $3.26B.  Revenue was lower than analysts’ fairly conservative $2.86B consensus for the third quarter.  I suspect there were more than a few deals in the pipeline that stalled as a result of acquisition rumors.  On March 18, just before the quarter end of March 29, the WSJ reported that IBM was in talks to buy Sun.  It’ll be interesting to see what 4Q revenues look like since the Oracle acquisition was announced at the start of Sun’s 4Q.

On a positive note, Sun’s software billings were up 28% yty.  However the growth is based off a comparison to Fiscal 3Q08 during which software billings were down 9% while Sun’s overall revenue was flat.  Had software billings been flat in fiscal 3Q08, the 28% growth in fiscal 3Q09 would have been 19% growth. Even at 19%, this is a huge bright spot for Sun.

Sun reported an operating loss of $169M, up 10-fold from a loss of $16M last year.  Another strike against the $1.5B target.  As a result, unlike others, I simply don’t see Oracle being able to reach its $1.5B operating profit target through cost cutting alone.  Oracle must grow Sun’s top line.

Top line growth will come from generating higher revenue from current customers and attracting net new customers.  With Sun’s current revenue trajectory, it’s difficult to see top line growth driven significantly from customer base growth.  It seems more likely that Oracle will have to raise prices, especially ongoing maintenance costs, in order to generate higher revenue from current customers.  Oracle implemented this strategy with BEA license and subscription prices after the acquisition.  I don’t see a significant price increase flying in this economy.  But if Oracle decides to go this route, it’ll be a boon for competition.  But I’m sure they’ve done the math and can stand to lose X% of customers as a result of a price increase and still generate enough revenue to make it worth their while.  Say what you will about Oracle, they don’t fear tough decisions.

Do you think an Oracle price increase is inevitable?

Follow me on twitter at: SavioRodrigues

Forrester’s John Rymer tweeted:

“Spoke with a client who believes the 4 top vendors are stifling innovation by crushing small vendors — with no hope in sight. Yikes”.

Working at one of the “4 top vendors”, it’s natural for me to disagree.

First of all, innovation occurs across the software industry, from “elder companies” (thanks Cote) to startups.

Second, most startups nowadays use some variation of the open source business model.  With the code out in the open, it’s difficult to argue that elder companies can “crush small vendors”.  Sure, an elder company could try to fork the code as Oracle did with RHEL.  But this strategy hasn’t proved successful to date.  An elder company can acquire the small vendor as Oracle has done with Sun/MySQL.  However, as we’ve seen with MySQL, if the community doesn’t approve of the acquirer’s actions, the community will fork the code and innovation will continue.  The open source business model severely limits the degree to which an acquirer can “crush” the acquiree, either deliberately or by happenstance.

Third, let’s look at elder company acquisitions of small vendors. Most deals have been after the small vendor has established itself in terms of usage and/or a revenue stream.  This too argues against elder companies crushing smaller vendors.  More often than naught, a sale to an elder company is part of a smaller vendor’s (or more likely their VC’s) long term plan.

I will concede that elder companies don’t stand idly by as competitors, big or small, introduce innovation into the market.  Elder companies respond with their own attempts to leapfrog the existing innovative product or offering. But hey, that’s competition for you.

What do you think?

Follow me on twitter at: SavioRodrigues

This post is not a commentary on the impact of Oracle’s profit target for Sun on Sun & Oracle employees. I don’t want to make light of any potential cuts that may result. I simply want to understand what it will take for Oracle to hit the $1.5B profit target for Sun:

“We estimate that 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. This would make the Sun acquisition more profitable in per share contribution in the first year than we had planned for the acquisitions of BEA, PeopleSoft and Siebel combined,” said Oracle President Safra Catz. “

I started with Sun’s fiscal 2009 results. Revenue from the first two quarters of fiscal 2009 is currently available. Going back to fiscal 2008, Sun’s revenue appears to be fairly consistent, at approximately 25% per quarter (see pg 92 of 172). I assumed we could double the first half of fiscal 2009 results to get a full year fiscal 2009 view. You can see this in the “Est. Full Year @ Run Rate” column. Next, I estimated “Sun’s Yr 1 as part of ORCL” column based on the assumptions below.

First, I assumed that product and services revenue would decline 12% and 4% respectively in the first year. These figures are the reported YTY declines for Sun’s product and service revenue in the first half of fiscal 2009 versus first half of fiscal 2008.

Second, I estimated that Sun/Oracle will be able to reduce the cost of goods sold. I assumed that a 10% decline in “Cost of sales-products” would be doable as Sun/Oracle could squeeze their manufacturing suppliers. Next, I estimated a 10% decline in “Cost of sales-services”. I assumed that Oracle would leverage its current maintenance and support teams to help curtail costs. However, since software accounts for less than 15% of Sun’s revenues, one could argue that Oracle doesn’t have the skills to provide the support and services to Sun’s systems products. For perspective, Sun decreased its cost of products sold by 3% and its cost of services sold by 1.2% from fiscal 2007 to fiscal 2008. My estimates are significantly higher. However, Sun has been in cost cutting mode this year, and I expect Oracle to continue the effort.

Next, I assumed restructuring costs would remain flat at $570M for the full year.

Now, let’s consider Sun’s R&D budget. Yes, Sun’s software portfolio has overlap with Oracle’s portfolio. The extreme argument is that Oracle will reduce the majority of Sun’s software-related R&D. However, Sun’s software revenue is estimated at less than 15% of overall revenue. So, if R&D spending is aligned with revenue, a maximum of 15% of Sun’s R&D would be at risk of being cut. I estimate a 20% reduction spread 5-10% in the software division and 10-15% in the hardware division.

The final operating expense category is “Selling, general & administrative”.

If we use the above estimates, then the Sun “division” would report a ~$800 million operating loss in its first year with Oracle. Since negative $800M is not equal to $1.5B profit, Oracle will look for SG&A cost reduction from Sun.

A 63% reduction in SG&A:
Working backwards with a $1.5B operating profit as the goal and the above assumption, I calculate that a 63% reduction in SG&A would be required. Wow. That is a big number, representing over $2.3B in cost reductions. It’s hard to imagine this large a reduction in just one year. Yes, there is overlap in SG&A functions between Sun and Oracle. But sixty-odd percent overlap? I find that hard to believe. Maybe Oracle will reduce Sun’s advertising budget, curtail JavaOne spending or curtail CHQ-level roles like strategy teams. But these are minor elements of a multi-billion dollar expense.

If 85% of Sun’s revenue and approximately the same level of SG&A spending is linked to Sun’s hardware business, can Oracle really find 63% of overlap or reduction in SG&A spending? Oracle doesn’t have any hardware-related SG&A spending today. So where will the cost efficiencies of this magnitude come from? At an extreme, one could argue that Oracle will reduce software-related SG&A spending. But this is closer to 15% of SG&A than 63% of SG&A spending.

For completeness, if Oracle can maintain flat Sun revenue, versus a 12% and 4% decline in product and service sales, a 33% reduction in SG&A would be required to meet the $1.5B operating profit target. Yes, 33% is more realistic than 63%.  But even a 33% reduction is difficult to see considering that ~85% of the current SG&A spending is linked to business lines that don’t overlap with Oracle’s current spending or staffing.

What do you think? Is the $1.5B Sun operating profit target achievable?

The AP is reporting that Oracle will buy Sun shares for $9.50/share, $0.10 higher than IBM’s reported offer which fell through.  The deal is expected to close in this summer.

Oracle estimates that Sun will contribute more than $1.5 billion & $2 billion to Oracle’s profits in the first two years respectively.

This will be very interesting.  I guess Oracle didn’t have enough on their hands with integrating BEA’s middleware suite!  It’ll be very interesting to see what Oracle does with Sun’s hardware assets.  I suspect that they’ll sell those assets off.  But I guess time will tell.

A few readers have begun to worry about the fate of MySQL.  This deal will be a test case for the actual freedoms of users when an open source product gets acquired.  Yes, there is an opportunity to fork the code if users aren’t happy with the acquiring vendor’s actions in the user community or with the product in question.  But what’s the customer value of a splintered community?  And up against the resources of an Oracle, can MapleSyrup Inc., the leading providers of support for MySQL in Canada, really stand a chance?  Methinks no.

More to come…

Matt Aslett’s post yesterday is one that will surely attract attention and possibly eggs from commercial open source proponents.  However, I believe he’ll be proven correct.  Aslett concludes with the following statement, which is backed up by data earlier in the post:

“If open source is to become more relevant to mainstream enterprise users then the focus has to shift from decreasing cost to enabling business practices and increasing revenue generation opportunities.”

I completely agree.

Our friend Matt Asay comments:

“Speaking of “who you ask is important,” have you considered that Savio has a vested interest in prospective buyers not fixating on cost? He works for a company that sells incredibly expensive software!”

Two things.  First, what I blog on InfoWorld and my personal blog are my own views.  I use my experience at IBM to provide color to these views, not to advance an IBM or WebSphere “agenda”. If I were tasked with the latter, I’d be looking for a raise!

Every piece of financial analysis I’ve done leads me to conclude that a mature open source vendor’s financial ratios are no different than their closed source competition.  Yes, a startup open source vendor can keep costs down and pass on the savings through lower priced products.  However, this cost advantage is not sustainable.

What happens when the $50k/server/year price point isn’t sufficient to market and sell the product, to invest in R&D, to invest in employees and to generate a sufficient ROI for investors?  Well, you’ll increase the price to $60k/server/year.  That works if your brand isn’t associated with “low cost”.  By fixating on cost, when open source products can deliver additional benefits, open source vendors are simply trading short-term gains for long-term challenges.

Second, IBM software prices range from $0 to tens of thousands of dollars.  Just because a product is $5k, $50k or $500k does not make it “incredibly expensive”.  No customer would pay $20 for a software product that only saves them $1.75 in costs or only helps drive $3.25 in revenue.  Prices are only sustainable when the business value being received is higher than the cash outlay.

Near and dear to my heart, the WebSphere Application Server (WAS) family has two very “low” priced products.  If you want a no cost, unsupported product, we’ve got WAS CE.  If you’re looking for an enterprise tested, fully JEE 5 compliant application server with broad programming model support, 24×7 support and a minimum 5 years of service from GA, plus a 3 year service extension available, we offer WAS Express for $2,305 in the US.   If you compare that price to a 24×7 support subscription from an OSS competitor I think you’ll be pleasantly surprised.  Oh, and if you’re looking at a large scale deployment with tens or hundreds of servers underpinning core business applications, our TCO story versus open source competition is insanely positive.

If anything, I have a vested interest in convincing open source vendors and prospective buyers to fixate on cost!  But that’s not how I roll…my mom taught me better.

Matt asks the question “Should Sun buy Novell?” which is predicated on the growth of Linux vs. Solaris.  Matt writes:

“IDC predicts that Linux will grow 21 percent year over year in 2009. I’m guessing Solaris isn’t seeing that kind of growth this year…or any time in the future.”

And:

“…(Sun) should double-down on its open-source strategy and fully embrace the operating system to beat in the 21st century: Linux.”

Several thoughts come to mind.  First, the notion of one operating system for any century neglects the history of IT.  Linux, or Windows, or Ubuntu or RHEL or Solaris or AIX is the right answer for 100% of customers in 100% of usage scenarios 0% of the time.  Choice matters.  It always has, always will in the IT market.  Even as the market consolidates, startups emerge to deliver choice.

Second, for Sun to shift from Solaris to Linux would be an incredibly risky proposition in the eyes of customers.  It’s one thing for Vendor X to buy Sun and make that decision.  It’s completely different for Sun to make the decision to leave customers’ Solaris investments out in the dark.  This decision would surely impact the trust relationship between Sun and its customer base.

Lastly, as customers get more accustomed to deploying workloads on hypervisors/clouds, the discussion around Solaris vs. Linux becomes less interesting; and from a Sun standpoint, easily becomes Solaris and Linux.

What say you?

Here’s a BusinessWeek article about how “Microsoft is Fighting Back (Finally)”.  The most interesting part is about Microsoft’s new “Windows Anytime Upgrade” strategy. Here are some details:

“Because of the smaller size of Windows 7, three versions of the program will come loaded even on lower-end machines. If a consumer on a cheaper PC running the “Standard” version tries to use a high-definition monitor or run more than three software programs at once, he’ll discover that neither is possible. Then he’ll be prompted to upgrade to the pricier “Home Premium” or “Ultimate” version.

Microsoft says the process will be simple. Customers enter their credit-card information, then a 25-character code, make a few keystrokes, then reboot. Brooks says pricing hasn’t been determined, but upgrading “will cost less than a night out for four at a pizza restaurant.””

After reading this, I instantly thought about Cote excellent post titled “The Return of Paying for Software” from last summer.  Cote wrote:

“When it comes to making money with software, the iPhone App Store is the glossiest example of trend I feel creeping up on us: people paying for software.

Yes, people have been paying for software forever, but the expectations for most consumer software of late has been that it’s free.

The change here is an environment where people will spend $0.99 to $20 for a piece of software. I often comment that this user-mentality – spending small amounts of cash on software – exists in the OS X world, but it’s been lacking from others.”

While I initially balked at the thought of a popup window with: “Hey, it looks like you can afford a high definition monitor, so why not get the most out of it with Windows 7 Home Premium, for an low price of $19.99?”, I’m willing to give this idea the benefit of the doubt.  This recent NYT article (via Cote – that man is Gold!) explains the success of an iPod/iPhone game called iShoot, and is a reason behind my openness to the Windows Anytime Upgrade strategy:

“In January, he released a free version of the game with fewer features, hoping to spark sales of the paid version. It worked: iShoot Lite has been downloaded more than 2 million times, and many people have upgraded to the paid version, which now costs $2.99. On its peak day — Jan. 11 — iShoot sold nearly 17,000 copies, which meant a $35,000 day’s take for Mr. Nicholas.”

Consumers are getting accustomed to acquiring software for instantaneous incremental gratification.  The consumer gets some value off the bat, but is faced with a purchase decision to get incremental value.  When the consumer decides to follow through with the transaction, the gratification is instantaneous, not tomorrow in the mail or through a 4hr download.  With the Windows Anytime Upgrade strategy, consumers would get some value off the bat.  Upon hitting a feature/function wall, a purchase decision would be presented.  And if the consumer chooses to transact with Microsoft, it seems that the incremental value would be provided on the spot, without having to download or acquire and install another DVD’s worth of an OS.

Seems like an interesting strategy that’s much closer aligned to how consumers pay for software today.  Maybe an unexpected outcome of Apple’s App Store strategy is to educate consumers ahead of Microsoft’s Anytime Upgrade strategy.

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