todays Barrons
McNealy Says Sun Will Gain
Market Share in a Slowdown
By Mark Veverka
Say one thing about Scott McNealy. He is unflappable. After asking him
every which way last week to offer his outlook on corporate information
technology spending for the next six to 12 months, the Sun Microsystems
chief executive barely budged an inch. "I don't do forecasts," he says. "I
learned long ago that you are never right."
But surely a $16 billion global titan like Sun must monkey around with
economic forecasting, at least a little bit? Steadfast in his stonewall, the usually
loquacious McNealy would have none of it.
After plenty of pestering on our part, McNealy served up a half-hearted
forecast of sorts, predicting poor short-term visibility coupled with plenty of
"volatility." And finally he tossed us a bone: "I can't predict the economy, but
we will gain [market] share."
There you have it. If there is to be a prolonged slowdown or recession,
prompting corporate bean-counters everywhere to ratchet back spending on
their computer networks, Sun will make lemonade from lemons and squeeze
the competition.
He then reminded us that patience is a
virtue for Sun stockholders. "I'm a
longterm shareholder, and I'll put our
five and 10-year stock charts up
against most anyone's," McNealy
imparted.
Indeed, from 1996 through late last
year, Sun's shares rose more than
20-fold. The surge in share price was
particularly impressive over the past
two years, as revenues and profits
grew anywhere from 25% to 60%
quarter-over-quarter.
Much of that growth was stoked by the Internet boom. Sun's
high-performance Web servers are at the heart of many a critical network.
And while once-fledgling dot.coms and e-commerce outfits were responsible
for fueling some of that success, the biggest opportunities for Sun rest with
Global 2000 corporations that have just begun to integrate their networks
with the Internet. Big business will continue to Webify, but how fast?
Sun chief financial officer Michael Lehman recently admonished Wall Street
analysts to lower their year-over-year revenue growth estimates to between
30% and 35%. That certainly isn't shabby, especially as the economy starts to
go on the fritz. But it may not be sufficient to justify Sun's rather frothy
forward price/earnings ratio of 47 times 2001 earnings.
At least that's the conclusion that was apparently drawn by many long-term
holders two weeks ago, when Sun, in the middle of this barrage of earnings
bombs, met analyst expectations only to see its shares get scorched. Big
blocks were dumped as it became apparent that the company was not going
to be able to maintain its torrid earnings and revenue growth against the stellar
comparisons of the past eight quarters or so. About a dozen brokerage
analysts have downgraded Sun shares since late last year, as they slipped
from a high of 64.66 to a recent 30.56.
Yet while the short-term outlook for Sun may be cloudy with poor visibility,
the long-term prospects for the Palo Alto tech giant remain relatively bright,
making us wonder how many quarters Sun's shares will stall before they
regain their trajectory. Naturally, the answer to that query depends on how
gloomy the economy gets and for how long.
Which is why we can appreciate McNealy's reluctance to get into the
forecasting game, especially after going several rounds with CNN's Jeff
Greenfield. The Sun chief, who had been fighting the flu, last week left his
sickbed to drop by Stanford University to tape an interview program for
public television called CEO Exchange. (The hour-long program is slated to
be aired on PBS in April).
During the program, which was taped before a live audience of Stanford
business students, Greenfield drew McNealy into the kind of meandering
discussion that you aren't likely to hear on CNBC, ranging from corporate
citizenship to education to energy policy. Of course, before the red light went
off, Greenfield did get around to asking McNealy about the "fella" in
Redmond, Washington. The funniest remark by McNealy was in response to
the question: Did he like "jerking [Bill Gates'] chain?" The answer: "It works in
the Pacific Northwest. So I keep doing it."
To make his point, McNealy, an avid hockey fan who still laces up the skates
in a competitive league, used the sport as an analogy. In hockey, it's not
uncommon for players to hit their opponents with their sticks in hopes of
provoking violent retaliation, McNealy explained. After getting knocked in the
head by a stick repeatedly, eventually the opponent retaliates by swinging
back, often getting caught by a referee and usually getting sent to the penalty
box. Consequently, the rival's team must play short-handed, which often
causes them to give up a goal.
Of course, Gates is in the penalty box for breaking antitrust laws, and
McNealy worked diligently with government prosecutors to help them win
their case. While Microsoft is challenging the ruling under appeal, there is
speculation now that the federal government under President George W. Bush
may go easy on Gates. And that would not set well with McNealy. "It's about
law enforcement. They broke the rules and don't seem very remorseful about
it," McNealy said during the taping.
In a separate matter, Microsoft recently agreed to pay Sun $20 million as part
of a legal settlement involving Microsoft's use of Sun's Java computer
language.
Still, as much as he may enjoy his Bill-baiting, McNealy has plenty of reasons
to stay focused on affairs back in Palo Alto. California's menacing power
shortage threatens some of the company's manufacturing plants, the Internet
bubble has popped, and an economic recession is possibly lurking around the
corner. So, when asked if he thought we were heading for a hard landing, the
resolute McNealy finally displayed a shred of concern. "Our assumption is
that we will make every quarter," he said, "[but] we are a little nervous."
Don't be fooled. While Intel sprang a pleasant surprise on semiconductor
capital-equipment makers during its earnings release about two weeks ago,
the general outlook for this extremely cyclical tech sector is still relatively
bleak. Intel injected life into some of the bigger names, such as Applied
Materials, KLA-Tencor and Novellus Systems, when the chipmaker revealed
that it would bolster its capital spending by more than 10%, to $7.5 billion, in
2001. Some of the semi-caps saw their shares surge up to 13% in single-day
trading in response to the news.
Intel said it plans to spend the dough to develop new systems that can handle
300-millimeter silicon wafers. The industry is moving toward larger
wafers-circular sheets of silicon-because they can produce a greater number
of semiconductors at a lower cost.
Don't get us wrong, $800 million worth of steppers and instruments is nothing
to sneeze at. But the trouble is, there is no guarantee that Intel will spend that
much money if the economy turns sourer than the company expected.
What's more, the outlook for the semicaps is getting uglier. Earlier in January,
top guns from the chip equipment and materials industry met for their annual
skull session on the Monterey Peninsula. And while these down-to-earth
executives are accustomed to the highs and lows that are a fact of life in their
industry, they are bracing for a slowdown that is looking worse by the day. At
least, that's what they were telling anyone who would listen at the strategy
symposium sponsored by Semiconductor Equipment and Materials
International, a trade organization.
"This is an affirmation that business is much worse than semi-cap equipment
companies had seen or were saying," says financial analyst Candace TenBrick
of William Blair & Co., who attended the symposium.
Recent statistics support the sentiment. Overall, orders decreased 10% in
December from November. And while orders jumped 29% year-over-year,
that was half as robust as the 60% increase in orders during November. The
back-end testing and packaging firms, such as Teradyne and Credence
Systems, are feeling the pinch right now. But the front-end equipment
companies, such as LAM Research and Novellus, will not be far behind, says
TenBrick, who has hold ratings on every semi-cap company she covers.
She suspects that the semi-caps are "pushing out" their orders as opposed to
out-and-out canceling them even though their customers are unlikely to honor
such orders for quite some time. "I think the third quarter will be the defining
quarter," says TenBrick. "Instead of reporting to Wall Street that they had to
cancel orders, they negotiate 'push outs,' " she says. "I think that's what has
been going on for at least the past several weeks."
Stay tuned. |
