Sun Microsystems Essay, Research Paper

With an employee workforce of four, Sun Microsystems was incorporated in 1982 by Andreas Bechtolsheim, Vinod Khosla, Bill Joy, and Scott McNealy. Originally began for Stanford University Network, Sun Microsystems has been a global leader in innovating products, services and support solutions for constructing and maintaining network computer systems. The first system built by Sun, the Sun-1 was introduced in late 1982 and was a high performance, UNIX based computer constructed of inexpensive materials. Within a year of incorporation Sun was operating in Europe, and soon spread throughout the world.

CORPORATE MISSION

From Sun s birth, there was always a corporate emphasis on the power of the internet and networking. A belief that the internet was the future was inherent in the corporate culture and was built into the company framework through the mission statement:

We enable customers to create breakaway business strategies by using our network computing products, solutions and services.

In an age where information is power. Sun provides the technology, innovation and partnerships that enable individuals or entire organizations to access information . . . from anywhere . . . to anything . . . on any device . . . allowing users to better differentiate and more effectively create breakaway business products and services.

This strong belief is reiterated in Sun s vision statement:

Sun is network computing. Everything we bring to the market is predicated upon the existence of the network, where Java is on every client and every server.

Sun s vision is for a networked computing future driven by the needs and choices of the customer. It is a vision in which every man, woman, and child has access to collective planetary wisdom that resides on the network.

These strong networking and internet beliefs made Sun the prime company when, in 1994, there was a huge surge in internet usage. At that time, roughly 30% of servers were made by Sun.

BUSINESS STRATEGY

Sun s objective is to expand its position as a leading global provider of network computing products and services. To achieve this strategy Sun is striving to:

 Develop network products and technologies that enable the Internet and the Net Economy

 Provide competitive solutions based on open industry standards

 Extend technology leadership and innovation

 Invest in support, education, and professional services

 Leverage strong industry relationships

FINANCIAL PERFORMANCE

Sun is a leading supplier of enterprise network computing products, and has a full range of services and support. The company s products are used for commercial and technical applications worldwide. As a global competitor, Sun is subject to exchange rate risks. There are a few markets Sun should be especially cautious of, including: Japanese Yen, British Pound, French Franc, and German Marc. Sun holds a large position in these potentially volatile markets. Despite its current recovery, Sun should be wary of the Japanese Market. Any major shift in this market could negatively impact its revenues. Another consideration it the value of the dollar. As the dollar strengthens in the US, the dollar value of non-US dollar based sales abroad decreases. In order to hedge these risks, Sun routinely uses options & futures contracts in foreign countries.

Common Size

Income Statemnt

Year Ending June 30 1999 % 1997 %

Net Revenues (in mil.) $11,726 100.0% $8,598 100.0%

Costs and Expenses

Cost of sales $5,648 48.2% $4,320 50.2%

Research & development $1,262 10.8% $826 9.6%

Selling, general, admin. $3,173 27.1% $2,402 27.9%

Purchased in-process R&D $121 0.9% $23 0.3%

Total costs and expenses $10,204 87.0% $7,571 88.0%

Operating income $1,522 13.0% $1,027 12.0%

Interest income, expense (net) $84 0.7% $32 0.4%

Income before taxes $1,606 13.7% $1,121 13.1%

Provision for income taxes $575 4.9% $359 4.2%

Net Income $1,031 8.8% $762 8.9%

Net income/common share-dil $1.27 $0.98

Shares used in the calculation

Net income per common share-dil 814 778

Currently, revenues outside the United States are increasing. This is primarily due to the continued market acceptance of Sun s network computing and product services. Approximately one half of the increases in revenue are due the continued strong demand for enterprise and work group servers, as well as increased revenues for their storage products division. Recently, the company has made an overall shift to premium service and support contracts in the service division. This change is advantageous due to the large installed base of high-end server products, and is primarily responsible for the increased unit sales in the service division. Sun has also experienced increased revenue from their professional and educational products.

The company continuously evaluates the competitiveness of its products and service offerings. These evaluations could result in re-pricing actions adversely affecting revenues in the short term. This is due to the company s belief that to keep the competitive edge in the market place, a company must continually improve existing products as well as introduce new ones. The company will achieve this even if it means the cannibalization of existing products.

Financial Statements and Ratio Analysis

After reviewing the company s annual reports and other historical figures, we can evaluate the current stock pricing trends and financial well being of the company. Based from this information, the company s net revenues have continuously increased over the last five years reaching 11.726 billion in fiscal year June 30, 1999. A common-size income statement analysis of the company shows us that Sun s cost of sales as a percentage of net revenues has decreased in 1999. In the technology sector, prices for products can often fall faster than manufacturing costs to produce them. Tight control over costs of sales is a positive sign for a company in this industry. This shows us that Sun is maintaining their competitive position in this area. The expenditures on research and development have increased slightly in 1999. This can be attributed to the continuous development necessary to stay competitive in this industry. Tech companies tend to grow much faster than companies in other industries. Because of this, R&D expenditures are especially important in the long term health of technology companies. Sun appears to be adequately using funds in this area.

The selling, general, and administrative expenses have increased in dollar value but remain constant as a percentage of revenue. Some reasons for the increases in SG&A are attributed to its continuous improvement of internal business processes, increased marketing costs, and increased head count needed to meet rising demand. However, it is imperative that the investments in SG&A should not rise as a percent of revenue for the company to remain competitive. The purchased in-process R&D line on the income statement reflects the amount of write-offs associated from newly acquired companies.

The information provided from the annual report for year ending 1999 however, is somewhat misleading. Two months after the annual report was filed with the SEC, Sun acquired Star Division Corp. on August 5, 1999. All the capital stock of Star Division shareholders was converted to the right to receive cash. The total purchase price of the company was approximately 60 million. No extraordinary expenses or the associated changes will show until the new annual report is filed for fiscal year 2000. Because of this, any assumptions made based on the 1999 figures will be distorted until the final effects of the merger can be evaluated.

It is Suns belief that the Star division will increase revenues with the introduction of new software later this year. Star s current direction in software development is consistent with Suns software architecture including the use of portal technologies. These technologies will allow users to access office applications via a single server using the Internet from many different devices including cell phones & personal data assistants. Sun believes they can harness synergies from this merger to amplify stockholders returns. The future success of this operation may greatly impact the companies competitive position. On a cautious note however, the company should be careful to not neglect the continuous development needed of existing products to remain competitive.

Both the company s quick ratio of 1.94 and current ratio of 2.44 far surpass its industry (Diversified Computer Systems) average of 1.33 & 1.71 respectively. This shows us that Sun maintains an advantage over its competitors by having substantially more assets compared to liabilities. The 1999 annual report also boasts of having almost no debt compared to equity. However, we know that with the merger of Star Division, Sun has picked up some long term debt raising its debt to equity ratio to .36 from 0. Even with the added debt, Sun is still beating the industry average of .44. This shows much internal strength for the company, but raises some concerns that debt leverage may not be currently utilized to its full potential.

The companies ROA and ROI ratios are continuously beating the industry. These values indicate signs of good management from within the firm. The firm received large returns on investment for fiscal year ending 1999. This however, may not be representative of future performance as it is not income generated by the firms primary operations. As such investors and management alike should be cautious. The company s ROE is slightly trailing the industry. This is probably due to the lack of debt leverage currently being utilized. The company s asset and inventory turnover ratios are lower than its industry. This can at least be partially explained by the company s dependence on its suppliers. Sun frequently enters into large contracts that are non-cancelable to retain its suppliers. This results in stockpiling and more importantly wasted or obsolete inventory. The technology sector is continuously changing & any inventory not immediately sold runs the increased risk of becoming obsolete in the future. This is an area where Sun could use some refinement. One possibility would be the use of JIT manufacturing or a more vertical integration with its suppliers.

The company s gross margin of 51.96% represents increased demand of higher-end market servers. The operating margin is also solid at 13.86% compared to 10.23% for its industry. This can be attributed to the tight controls on costs of sales as compared to the increasing revenues. Sun s net profit margin is 9.75%. Although seemingly small compared to the S&P 500, this margin significantly beats the industry average of 7.23%. The low profit margins throughout this industry characterize this highly price competitive market as it converts product to revenue.

Sun s stock is rated by Wall Street Analysts as a strong buy. It has been forecasted to perform better than average on 2000 & 2001. The companies EPS forecast for fiscal year 2000 is $0.90 and judging from its first two quarters, it appears to be right on track. Although Wall Street has high confidence in Sun, the next earnings release will be April 13, 2000 and any significant variation from expected earnings could have very adverse affects on the price of stock.

The P/E ratio skyrocketed from just 53.8 in June of 1999 to its current price of 122.16 as of March 15. This indicates that investors are willing to pay a significant premium for Sun s earnings (about $122 for every dollar of earnings). Both the Sales and EPS growth rates also indicate investors are paying large premiums for growth relative to Sun s peers. These premiums may indicate an inflated stock price.

Future Predictions

One of the best ways to value a company can be to forecast future cash flows & then discount them back to today s net present value. Using this technique, we projected earnings 10 years into the future using the net income from the 1999 annual report and a growth rate of 20%. The 20% rate is consistent with the company s historical growth rate. Next we discounted those future cash flows at a rate of 15% to compensate for changing markets and the cost of capital. By doing this we were able to arrive at a NPV from those cash flows. Finally by subtracting long term debt and dividing by the number of current shares outstanding we were able to arrive at the companies intrinsic value of about $35.00. By comparing this value to the current stock price of $89.81, we can see that Sun appears to be overvalued by investors at this time. This is probably due to the investor excitement from the increased revenues and its strong ROA and ROI.

Sun s management will need to be very cautious of any unexpected changes in earnings. These changes could trigger an adverse affect on the current stock price and curb investor excitement in the company. This could have a negative consequence on the company s future operations. Management must always look at how the firm is valued from outside sources if it is to continue the goal of maximizing shareholder value.

COMPETITION

Hewlett Packard (HP) is a leader in the computer industry. They got their start out of a garage in 1938. Considered to be innovators their business has grown over the years. The main focus of Hewlett Packard is to be a global provider of computing and imaging solutions for business and home. This takes into account the rapidly growing internet with an emphasis on e-business. While HP s performance is strong they are not as volatile as Sun because they own a big chunk of the printer market. They are competing with Sun in the huge server market. Hewlett Packard realizes the expansion of the internet and they will be a competitor for a long time in the future.

Next we have Big Blue International Business Machine (IBM) and they have been a global force for many years. Their main focus is to provide customers with solutions through the use of advanced information technology. These solutions include technologies, systems, products, services, software and financing. IBM is a stable company that is trying to maximize shareholder wealth and at the same time recognizes the key to the future. They will be a big competitor of Sun s due to the growing demand for internet solutions. IBM has formed alliances with Cisco, Intel, Motorola, Nokia, and Palm to start e-service. This is to combat the wireless revolution. IBM in 1998 started to create an infrastructure to take advantage of the fast growing internet. The mission for them is access anytime anywhere. The key to IBM getting more involved is because Experts say that in the near future there will 1 billion wireless subscribers. Everything digital is due to double in the coming years. IBM as well as Sun does not want to be left in the dust.

Our third major competitor is Compaq Computer. They were incorporated in 1983. They currently sit as the #2 computer company in the world. They began their onslaught on e-business back in 1988. They use a company called Electronic Data Interchange (EDI). This gave them a direct portal to get information to their customers faster over communications lines. They also use a Just in Time process to cut costs, reduce cycle times. Overall this improves their cycle times. Their main focus is to design, develop, manufacture and market hardware, software, and services to individuals.

Don t let Compaq s numbers fool you. Compaq has had their problems in the past of growing too fast, and are rebuilding for e-commerce. They are poised and confident that they will lead consumers to a paperless environment.

Silicon Graphics is a leader in digital media solutions. They accomplish this through large servers. Their key to success is to engage in production of a broad range of visual computing systems. These systems deliver advanced 3D graphics and computing capabilities. They have a definite power in providing audio and video over the internet. Huge servers store the enormous amounts of data needed to accomplish these types of applications. Clearly they are in a growing mode. There systems have been recognized just recently at the Academy Awards for the Phantom Menace, Stuart Little, and The Matrix. To this point Silicon Graphics is in the red but with the growth available to them, they could steal market share. Sun really has to watch out for this mover and shaker.

Management Effectiveness

Hewlett Packard IBM Compaq Sun Industry

Return on Equity 16.34% 39.96% -6.35% 26.23% 26.23%

Return on Assets 8.86% 9.09% -3.10 14.52% 11.85%

Return on Investment 14.24% 16.02% -4.86 21.90% 20.94%

EXTERNAL FACTORS

Strengths

We found Sun to be one of the most influential companies within its industry, which possesses much strength. Most importantly, Sun has had and continues to have strong international presence. We assigned the strongest weight to this because we feel that having a strong international presence will have a similar effect in the domestic market. As for some other strengths, for the last several years Sun has managed an average 10% sales growth. Scot McNealy is one of the strongest and respected leaders in the industry. He has greatly motivated his employees with such things as his motto, Kick butt and have fun. They also have one of the largest cash balances, which allows for any necessary investments. Last but not least, they have one of the largest market shares with their server networks.

Weaknesses

Even with Sun being among the leaders of its industry, there are still some weaknesses that they need to work out. First of all they have a strong dependence on their suppliers. This isn t allowing them to be as flexible as they need to be. Another problem is that they need to work on their inventory forecasting. For this, we believe that they need to develop a Just-In Time inventory system. For these problems we have assigned the strongest weights because it can be very dangerous for a company to have too much or too little inventory in such a rapid changing industry. As for some other problems, Sun has had a very long and ongoing vendetta with Microsoft that has probably been more of a distraction of their own progress if anything. Sun problems have also resulted in the slow evolution of their Java systems. This has allowed other companies to produce and market similar products. Although, Sun has one of the largest cash balances, they need to better utilize their debt resources. They need to use leverage because cash sitting in the bank is not making them any money.

INTERNAL FACTORS

Opportunities

With such a fast growing industry, there are tremendous opportunities afoot. Sun has had a strong internet history. They created a vision statement and have continued to follow it through with great success. Sun has also developed a strong global position. They currently provide about half of the servers for the international sector. For these two reasons alone, we have assigned them the highest weights. We feel that it is usually important to have to have a strong background in order to seek other opportunities. As for some other opportunities, Sun has formed an alliance with America On Line. This was a wise decision because AOL is the world s largest internet provider. E-commerce trends have also been skyrocketing and we feel that there is plenty of room for growth. Finally, there has been an ongoing battle between the Government and Microsoft. This has slowed Microsoft down and should allow Sun to gain a better position within its industry.

Threats

While in an overall strong position, Sun still has several threats that could cause serious harm. The strongest threat we have found is the rapid industry change. The main problem is with their heavy supplier dependence. Again, they need to develop a JIT system in order to remain more flexible with the changing times. Another problem is that we feel there is a consumer acceptance issue that may harm them. Simply because Sun is not nearly mainstream as some of the competition. Microsoft still has a monopolistic hold on the industry that may still pose as a threat. Although, we feel that Sun is in a strong enough position to challenge their advances. Finally, there is a fierce price competition that can serve a threat to their business. This competition is usually not good for business, but consumers should benefit from this.

SWOT ANALYSIS

We feel that overall Sun is a great company, but with any company there is still room for improvement. Therefore, we have made several recommendations within the TOWS Matrix that should benefit Sun. For our Strengths Opportunities Strategies, they should use their resources to expand their Internet and global positioning. They should also strengthen and create new alliances to increase market share. Their alliance with AOL was a step in the right direction. For Strengths Threats Strategies, they should utilize their international position to combat competition. They should also use some of that large cash balance to broaden consumer acceptance. For Weaknesses Opportunities Strategies, Sun can use alliances to build a better supplier network. Sun should also put more emphasis on the Internet industry, because this seems to be the fastest and most promising growing area. For their Weakness Threats Strategies, we feel that they need to focus less on their vendetta with Microsoft. This become too much of a distraction for them. Finally, they need to develop a JIT inventory system in order to stay ahead of competition and avoid any related threats.

TOWS Matrix

Internal Factors Strengths Weaknesses

S1 Strong international position W1 Vendetta w/ Microsoft

S2 Sales growth W2 Dependence w/ suppliers

S3 Strong leadership W3 Slow evolution of Java

S4 Large cash revenue W4 Inventory forecasting

External Factors S5 Server networks W5 Utilize debt resources

Opportunities SO Strategies WO Strategies

O1 Strong internet history – Use resources to expand – Use alliances to build

O2 Alliance with AOL Internet & global position supplier network

O3 Strong global position – Strengthen alliances to – Emphasize internet

O4 E-commerce trends increase market share

O5 Government vs. Microsoft

Threats

T1 Microsoft monopoly – Utilize international position – Less focus on Microsoft

T2 Rapid industry change to combat competition

T3 Consumer acceptance – Use cash to broaden – Just in Time

T4 Price competition consumer acceptance

RECOMMENDATIONS

Sun has a great history. They may be young, but Sun is still a force. We as a group feel that it is vital that Sun Microsystems focus on itself. Sun should downplay the Microsoft legal battle. They should reinforce their dominance on the server market and the internet. Expand their networks to a position where everybody else has to catch up to them. They need to ensure that they avoid entropy. Sun does not want to rebuild. They should want to remain a global leader. Last we feel they should focus on their suppliers and use more of their corporate muscle. They need to be more demanding on their suppliers, make suppliers bend to Suns needs. If suppliers don t Sun has the opportunity and money to buy what they want. Sun has the ability to dictate its future.

REFERENCES

E*Trade.com, March 2000 Quotes

Sun Microsystems, Inc. 1999 Annual Report

Sun Microsystems, Inc. s home page: www.sun.com

Sun Microsystems, Inc. 1999 10-K Report

Wheelen, Thomas and Hunger, J. David, Strategic Management and Business Policy, Prentice Hall (2000).

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