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Stock Brief
Sun Microsystems: Poised For a Breakout
Daily commentary updated Dec 3, 1996
Company Brief
Sun Microsystems (SUNW 59 5/8) is a leading supplier of networked computer products including servers, software, workstations and
microprocessors. The UNIX operating systems is the foundation for SUNW's open systems approach. High-end servers are accounting for a
growing percentage of revenues due to the positive reception of the company's UltraSPARC product line. The improved product mix should
enable Sun to maintain margins despite the pricing pressures witnessed in its low-end workstations. FY96 revenues jumped 20.2% to $7.1 bln.
Sun generated 51% of its FY96 revenues from international operations. The company continues to expand its presence overseas, having
yesterday announced that it was chosen by China Internet Corp (CIC) to provide equipment and technology for CIC's Internet/intranet
network for China.
Bullish Trends
Sun Microsystems should continue to benefit from its position as the dominate player in the rapidly growing Internet/intranet markets with
the introduction of its Netra servers which offer preconfigured solutions for net publishing. The company's comprehensive Internet software
offerings, including Solstice'sfirewall capabilities, and the long-term potential of Java, will also support strong double-digit revenue growth in
this market for the next few years.
Strong sales of the company's recently introduced UltraSPARC workstations and servers have resulted in a record backlog of over $500 mln.
Though licensing fees from Java remain unsubstantial, the programming language has drawn considerable software development interest and
support from other computer makers. As more applications are hosted in Java, Sun should benefit from the creation and marketing of more
Java-specific devices. In the meantime, Java draws businesses to Sun's other products.
The enterprise server market is expected to post annual growth of over 50% over the next 3 to 5 years. Sun's new products, strong
management team and international presence leave it well positioned to exploit this growth and increase market share.
Valuations
Recent concerns over pricing pressures on the company's lower end products resulted in a sharp pullback from the stock's 52-wk high.
Though shares of SUNW have bounced off their lows, the stock remains attractively priced for long-term capital appreciation given its
projected annual growth rate over the next few years of 20%. At its current price, SUNW trades at 17x estimated FY97 earnings of $3.50 per
share and 1.3x projected sales. This leaves SUNW trading at 85% of its growth rate, a discount to the industry and to the overall market. As
fears of margin erosion are replaced by excitement over strong earnings growth, look for SUNW's multiples to expand. We look for the stock
to trade at 100% to 110% of its growth rate. Based on this assumption our 6- to 12-month price target is 70-77.
Risks
Increased competition.
A price war which leads to material margin erosion.
Parts supply constraints
Strong dollar
Significant economic slowdown
Conclusion
New product cycles, an improved product mix, a strong balance sheet, quality management and rapidly growing markets leave Sun
Microsystems's well positioned to experience solid double-digit revenue and earnings growth through the year 2000. Though increased
competition has led to pricing pressures on the company's low end products, a shift in focus to higher end servers should keep margins from
experiencing significant erosion. We think these fears have created a good long-term buying opportunity for growth oriented investors. Our 6-
to 12-month price target is 70-77.
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