JP Morgan Comments on MSFT, AOL, LVLT and SUNW
By: J.P. Morgan
10/19/00 7:25:26 AM
Sun Microsystems (BUY)
THIS IS WILD; RAISING ESTIMATES AND TARGET TO $130
· Sun reported 60% revenue and 80% earnings growth for fiscal 1Q, a performance that puts everyone else to shame
· Their outlook keeps improving, for the fourth consecutive quarter, and we have taken our estimates up
· Sun’s gross margin declines are not a concern; they paid up for DRAM, took share, and still beat expectations
We can’t use any more superlatives, because we ran out of them when Sun posted 42% revenue growth in its fiscal 4Q. We were pretty excited about that. Silly us. Our excitement was obviously pre-mature, since Sun has now bested that with a whopping 60% growth number in fiscal 1Q 2001. That’s pretty much the whole story in a nutshell. This company is out to grow, expand market share, and trump the competition. The battle cry seems to be “no excuses.” So if components are in short supply, the company will pay up for allocation, rather than wordsmith an explanation about how revenues could have been better, if only … (Sound familiar, IBM [IBM/$95.44/Buy]) The bottom line is, in our view, that revenue performance of the company puts everyone else to shame, execution is just what the doctor – or, rather, the fitness coach -- ordered, and the outlook is, you guessed it, improving. So for us folks biased toward successful stories and upward mobility in the P&L, we believe this remains a stock to own. We rate Sun a Buy. We have a new target of $130, reflecting the improvements in our forecast.
So what about our take on the margins, the gross margin primarily, which declined from 52.1% to 48.2% between 4Q and 1Q. The party line is that Sun went out and paid up for DRAM in order to ensure a high shipment rate. We actually believe the party line, but for the sake of argument, let’s say there was more to it. Let’s suppose for instance that Sun, concious of the availability of those great new UltraSPARC III servers (with gobs more Internet-readiness, performance, scalability, reliability and software features), decides to price aggressively, in effect creating a prie performance equivalency between the tail of the existing generation (UltraSPARC II) and the permutations of the new stuff. We might get some gross margin impact, but on the other hand, Sun is still shipping product very briskly and turning in a feast of a revenue number and premium EPS to boot. Any objections? Or take it a step further, i.e., imagine the competition (hiss) is making a run at some market share, and Sun is responding with price concessions. In the end Sun gets the growth, takes share, cements its franchise, and, still, shows EPS ahead of expectations. Any complaints? Note that the company flatly denied that it was pricing to confront competitors.
The bulk of the discussion yesterday between investors and the company was not around performance of specific business segments or geographic regions. There was no single star of the quarter. Everything did well, leaving Scott McNealy the luxury to expound on the virtues of the Java and Jini technologies, and the breadth of the Java community. It is probably good to get these reminders of how Sun actually did build its franchise. Certainly, the commitment to Internet-friendly Unix in contrast to other vendors hedging their bets lest the Wintel commodity model take over the world, landed the enterprise market right in Sun’s lap. However, we continue to believe that technologies such as Java, particularly Java, were the glue that ultimately bound Sun to the enterprise and Internet infrastructure markets. Recognizing that is probably still critical to understanding the strength of Sun’s business position and likely continued competitive resiliency.
All this to say that the bulk of the discussion was in effect around the guidance. It’s going up, and the company through its meticulous CFO Mike Lehman, has a conservative bent when it comes to projecting. So the question is will revenue growth even exceed the company’s upwardly mobile guidance. We have taken the approach that the elements of caution the company is urging us to consider have valid underpinnings. Indeed, comparisons from the March quarter onward do become tougher, particularly in Europe with the weakening of both pound and the Euro in the latter part of the current calendar year. So we do accept the assumption of a front-loaded quarter when it comes to revenue growth. Where we come out is shown in the table below. In a nutshell, growth is stronger throughout the balance of this year, but more markedly in 2Q, with moderation (No, we will NOT say slowing!) in the second half. We are also embedding the company’s conservative gross margin assumption (49-50%) in our own model.
This is the best story in the computer business and the worst we can say about Sun’s situation is that 60% revenue growth is a tough act to follow. But we can just feel the moment when they turn in 49% next quarter, which we believe they will, and someone asks, "But what have you done for me, lately?" We’ll deal with it, the stock should head up. Sun is a great story, and we rate the stock a BUY with a $130 target.
(J.P. Morgan Securities Inc. acted as co- or lead-manager in an offering of securities for IBM within the past three years. The analyst or research associate holds a position in IBM and SUNW.) |
