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?