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Why Sun Micro Will Rise Above Its. From Etrade
Tech Knowledge
Friday February 18, 2000 (4:47 pm ET)
Why Sun Micro Will Rise Above Its Competition -- Again
NEW YORK, Feb. 18 (Standard & Poor's) - Talk about a hot ticket. About 300 people (mostly
industry and financial analysts) attended Sun Microsystems' (SUNW) worldwide analyst
meeting on February 7-9, 2000. Just seven years ago, only 20 people were in attendance.
And that's not the only sign of Sun's rising prominence. Its stock has enjoyed an equally
impressive gain over the years -- despite surging some 81% last year, Sun shares are already
up nearly 20% year to date.
"Category owner"
Sun has found itself in the enviable position of having to justify its stock's high valuation. Sun
sees itself among the companies best described as "category owners" -- i.e., companies with a
singular focus and strong market position that can "set the agenda" for the entire industry.
Taking this argument to its logical conclusion, a category owner can thus benefit from stronger,
more sustainable revenue and earnings growth as it takes something of a first mover advantage
in emerging areas as the industry evolves. Imagine this concept on steroids for technology
industry leaders like Sun, given the already overall healthy rate of growth for the industry on
average.
Sun defined the category that it owned as Internet computing. Clearly, Sun has garnered the
leading mindshare amongst dot-com companies. But Sun's stellar stock price appreciation is
already a reflection of that.
So what did we learn to make us think there's upside in Sun shares from here? It's the traditional
argument, set against the backdrop of the New Economy.
Outperformance catalysts
Sun's shares should beat the market because its earnings outlook appears to be at a critical
inflection point. Sun has witnessed a surprising acceleration of revenue growth for a company
of its size (now with some $13 billion in revenues). The company is now embracing the 25%
revenue growth rate analysts have long though it could achieve given its success in penetrating
key categories of the rapidly growing server market.
To put this in perspective, Sun recently posted revenue growth in its December 1999 quarter of
nearly 28%, coming off the heels of the prior quarter's 25% growth. Sun hasn't posted two
consecutive quarters of above 25% growth since 1994 (December 1994 and March 1995
quarters). And not only does this 25% revenue growth rate appear sustainable, but based on
Sun's meeting we believe that there could be some upside.
Strike up the bandwidth
Here's why. Sun has again taken the lead over its peers in what we believe is a critical area.
Few companies in the computer hardware industry have spoken at length about how they will
respond to the enormous amount of bandwidth expected to come on line in the next several
years. This will occur as spending on new networking technologies enables U.S. network
capacity to go from roughly 21.7 Terabits/second to an anticipated 99.8 Terabits/second by
2001.
Sun spoke easily and insightfully about the implications of OC (Optical Carrier)-192. OC-192
refers to SONET transmission rate of 10 Gbit/sec. Sun's renowned Chief Technology Officer
Greg Papadopoulos notes that we are coming up against a critical juncture in which the pace of
growth in bandwidth (packets/second are doubling about every 6-9 months) exceeds the
improvement of the microprocessor under Moore's Law, which calls (roughly speaking) for
microprocessors speeds to double every 18 months.
Bigger bandwidth has enormous implications for everything from the type of infrastructure used
to support the Net, to the software industry's business model, to the basic way the Internet is
used every day. Sun is clearly ahead of its peers in thinking logically about this and we believe
its product introductions and competitive position will benefit from this first mover advantage.
These are all key dynamics for stronger than expected revenue growth. However, operating
margins could also expand, and this is something we believe could occur within the next year
despite heavy investment spending by Sun. At the same time, operating expenses have
accelerated as Sun adds resources in sales and support to address its burgeoning customer
base and sizable new market opportunities. The company has also identified cost savings
achievable with programs (under the eSun initiative) to leverage the Internet to reduce its cost
structure. Cost saving achieved through web-based ordering, and order tracking are pretty
straightforward and we understand Sun has made good progress here.
Stacking up
Finally, Sun discussed three big bets the company is targeting. One is massive scale, which it
has more or less proven. The second one is continuous real-time, which has been a recurring
mantra in many technology journals, and not likely to be disputed given the general acceptance of
pervasive computing and the push for all-optical networks.
Sun's third bet is a little more controversial - the "single stack." A "stack" can mean somewhat
different things in programming and networking, but in very general terms, a stack refers to
layers that work together. What Sun is proposing is basically that its software and hardware are
built into a single stack or solution for customers, and that has implications for its product
roadmap.
For example, Sun's Solaris 8 operating system (OS), has an app server and web server, as well
as other historically separated features integrated into the OS. What is controversial about this
setup is that it sounds quite similar to the old days of proprietary systems -- which the industry
has fought hard in recent years to shake. Still, there may be a place for this approach the current
buildout of the Internet and its pace of growth. We have found a number of companies supplying
this infrastructure and placing reliability and compatability in the forefront of priorities for its
dot-com and other Internet-related customers talking about the need to "own" the entire solution
supplied.
As Sun predicts, its big bets, fueled by increased R&D activity, will take about five years to pay
off. And so, while Sun's current outlook appears compelling as the premier Internet computing
infrastructure play, its long-term competitive position also seems among the strongest of
"category owners" in the technology industry.
Why it's a buy
S&P has found that time and again, companies with leadership positions in strong growth
markets, visionary management and a focus on asset management are key companies to own.
Sun is one such company, and while its valuation may appear rich at 66 times our calendar 2001
EPS estimate of $1.40, it remains attractive as the premier Internet infrastructure play, with
multi-layered Internet opportunities leveraging strong intellectual property. That's why we have a
(buy) recommendation on the shares.
Ralf |
