A HOT SUN SHOULD KEEP
WARMING INVESTORS' HEARTS
Its stock is already zooming. Now analysts are busy raising price targets
When Ivan Socher first learned that a deal was brewing between America
Online (AOL), Netscape Communications (NSCP), and Sun Microsystems
(SUNW), he immediately saw immense possibilities and bought some stock for
Samson Partners, the $8 million private fund he manages in Arlington, Va. But
he didn't buy shares of AOL or Netscape. He bought Sun.
While the merger that stands to change the Internet landscape is between
AOL and Netscape, Sun Microsystems, which has formed a wide-ranging
strategic alliance with America Online, may turn out to be its biggest
beneficiary. Sun, based in Palo Alto, Calif., seems to have assured itself a key
role in building the Internet of the future. And thanks to the terms of its deal
with AOL, which require no major up-front investment from Sun, it has taken
on little of the financial risk.
Why would Sun be the winner in a deal AOL triggered? For starters, Sun,
which makes high-end corporate computers, software, and chips, and also
provides service and support, gets to be a lead technology supplier to AOL,
the premier Internet access company. The relationship should help Sun boost
its sales to other Internet service providers, if only because it has provided
Sun with valuable brand-name-building publicity in recent days. Over the next
three years, Sun will sell systems and services with a list price of $500 million
to AOL -- about $300 million in business after discounting, analysts estimate.
SALES SURGE. Sun also gets to add Netscape's browser and E-commerce
software to its arsenal -- which is why AOL wanted Sun in the deal. Given
Sun's credibility among corporate clients as well as its vast sales force, sales
of Netscape products should surge. "I think Netscape has some good
technology that it was having a tough time selling," Socher says. Sun has
agreed to pay AOL more than $350 million for licensing Netscape software
and for joint marketing and advertising costs. Ultimately, Sun and AOL will
develop the next-generation of Netscape Navigator together.
Bottom line: Sun can now sell Internet service providers and companies that
want to set up shop online all the software and equipment they need.
Through its partnership with AOL, it even can hook them with high-traffic Web
sites. "This gives them a strategy that includes offering complete end-to-end
solutions," says analyst Megan Graham-Hackett of Standard & Poor's equity
research group.
The deal is also a clear endorsement for Java, Sun's programming language
that can be used to create software that can run on any type of computer or
operating system. Part of the arrangement between Sun and AOL involves
developing low-cost "network appliances" using Java that will let AOL
members log onto the service from personal devices and cell phones. Java
will also be incorporated into other Netscape software. "This increase in
pervasiveness should encourage application developers to write more
applications for [Java]," wrote Steven Milunovich, a Merrill Lynch analyst, in a
Nov. 25 report.
Plus, the more devices there are that can reach the Net, the more servers
Sun should be able to sell, points out Morgan Stanley analyst Thomas
Kraemer in a Nov. 25 report. "Sun brings the robust back-end, or plumbing, to
the party," he wrote.
NEARLY DOUBLED. The only cloud in this sunny scenario for investors is
that a lot of the recent good news is already reflected in Sun's stock price. Its
price has nearly doubled in just the past six weeks. It traded as low as 39 on
Oct. 8 and closed at 75 3/4 on Nov. 25. Stalled in the low-40s for much of this
year, the stock began to rise after Sun's Oct. 15 earnings report. For its fiscal
1999 first quarter, Sun reported net income of $198 million, a 21% boost that
exceeded Wall Street's expectations. Investors cheered again on Nov. 17
when Sun won an early round in its suit against rival Microsoft (MSFT) over
an alleged violation of its Java licensing agreement.
Since the news of Sun's role in AOL's deal with Netscape began to surface on
Nov. 23, Sun's stock price has risen further. It's approaching the price targets
set by several Wall Street analysts, though these seers are revising their
numbers upward.
Even though the deal is not expected to add to earnings in 1999, some
analysts believe that Sun deserves a higher multiple since it is now becoming
more of an Internet play. In his Nov. 25 report, Kraemer rated Sun a strong
buy and raised his price target to $85, or 28 times his 1999 earnings
estimate. "While this blows past Sun's historical trading ranges, the potential
markets Sun is pursuing are enormous," he wrote.
Milunovich boosted his price target on Nov. 25 to $86. "This new
announcement shows that there are a lot of new opportunities open to Sun
and argues for a higher valuation," Graham-Hackett, agrees.
Sun can't keep rocketing forward forever. But Kraemer is expecting more
good news in early December, when the company holds its quarterly
operations review and launches a new Java Developers Kit. And long-term,
the deal with AOL could be a step toward making Sun a key provider of
indispensable software and hardware for the Internet. "Net-net, there is very
little downside," says Graham-Hackett, "but strong potential for very good
upside to the deal."
By Amey Stone in New York |
