There is more than meets the eye!

Sun Microsystems buying StorageTek looked like another mistake from Mr McNealy. But closer examination revealed what my mom told me long back…

On June 02, 2005, Sun Microsystems announced its plans to acquire Storage Technology Corporation or StorageTek, as it is popularly known. And most analysts and doomsday soothsayers called in the last nail (I had heard that before). As I sat in my office looking out, I was struck by what my mom told me very long ago. “Son,” she said, “There is always more than meets the eye and the obvious is not always true.”

While I often thought this held true for ERP, I did not know the others in the IT industry were also driven by it. And I thought lets investigate to see if this holds true for this as well. And in my enthusiasm, I started to search for what was not the obvious in this particular acquisition. And here is an account of what I discovered.

The Industry View
As part of the all cash deal Sun will pay a consideration of $4.1 billion or $37 a share to acquire StorageTek. In a release issued by Sun, it said that the acquisition would strengthen its position in the market for managing information from creation through long-term storage to deletion. The companies expect to complete the acquisition in the next two to three months. The all cash deal sent some ripples in the global market, but the real question is whether any of the players in the storage and the ILM space will feel any real heat.

Selling servers alone is not a profitable business any more. As a consequence, more and more vendors are offering a complete bundle of storage hardware, software and services. And Sun’s current storage business is not something it can be too proud of. This came at the forefront during the reporting of the quarterly financial results in April this year. Citing it as a cause for the $61 million loss that it made, company executives said that the rate at which customers purchase Sun’s storage products along with servers had declined over the last three quarters. On the other hand, both of its systems competitors sell more storage than Sun, in terms of value and as a proportion to their server business. For instance HP's disk storage systems business was almost 40% the size of the server business in 2004, compared to Sun's 24%. Both HP and IBM have larger revenues coming to them from storage services, storage software, and tape drives. When combined with StorageTek's products, the integrated portfolio could prove quite attractive to customers. So this means Sun is in a better position to breath down HP and IBM’s necks. However EMC has not much to worry about as neither Sun nor StorageTek have traditionally done a good job at selling primary disk.

It is old knowledge that the need to comply with government regulations such as the healthcare information privacy, Sarbanes-Oxley act, new FDA regulations, and securities compliance is amplifying the demand for storage. With StorageTek under its belt now, Sun can go beyond cradle-to-grave management because the company can add its significant portfolio of privacy, security, access management and ID management software. This will thus help it compete further with IBM, HP and EMC who have been offering next generation data center solutions. An obvious outcome therefore will be stronger push for ILM sales driven by Sun along with compliance and governance solutions over next twelve to 18 months.

The flipside to the whole situation however will the impact on StorageTek’s existing OEM relationships. While Sun was StorageTek’s biggest OEM customer, HP has been an important partner as well. And in May this year, StorageTek had announced an extension of its partnership with HP to deliver mid-range storage products. As part of the tie-up, HP was to provide StorageTek with LTO Ultrium tape technology. Since HP competes head-on with Sun in the server market, one can at the outset assume that the HP-StorageTek deal is over following Sun's move. Competitors in the industry are known to source from each other in the spirit of competitive cooperation and it has come to be recognized as a common business practice. Sun executives were quick to point this and emphasized that Sun is committed to developing the existing OEM relationships. An aspect of importance here is that the relationship extends only to cover storage hardware, which is not a significant part of the value chain.

A Prognosis for Sun
One of the most obvious benefits for Sun will be its ability to arrest the slide in its server business. Its share in the worldwide server, which stood at $12.3 billion in the first quarter of 2005, slipped to 9.5% from 10.3% a year earlier. Sun was way behind IBM (30% market share), Hewlett-Packard (28%), and even Dell (10.8%). As indicated earlier the StorageTek purchase is intended to help Sun compete in the next-generation data center market, where virtualized pools of computing, networking, and storage resources co-exist. IBM, HP, and EMC have aggressively pursued their own virtualization strategies.

While sales of StorageTek's tape-automation and disk-storage products have grown slowly in the recent past, the company brings invaluable experience in intelligent data management and expertise in helping large companies manage heterogeneous servers and storage as a single network. While the growth of tape is expected to be relatively flat, the sustained revenue and profit pool remains substantial. With this acquisition, Sun will more than double the size of the company's storage software revenue and be well positioned to capture a meaningful portion of the tape opportunity.

One of Sun's biggest challenges in the storage market has been sales coverage. The deal brings into the Sun stable an army of over 1,000 storage sales specialists and nearly 2,000 storage service professionals. Add to this a combined product roadmap, Sun will have the broadest product line in the industry. The ILM opportunity now seems within Sun’s grasp. An opportunity that on last count measured about $65 billion annually.

Compelling financials was another reason for Sun to pick up the $4.1 billion tag. Was it really $4.1 billion? Lets put together some simple mathematics first. On a cash basis the deal took $4.1 billion to complete, StorageTek has $1 billion in cash - meaning in reality it took only $3.1 billion to acquire the company. On $3.1 billion in cash, Sun would generate an annual income of $100 million from interest. Using the cash instead to fund its acquisition of StorageTek, its earnings equal to StorageTek’s net income and cash flow. This exceeds $100 million. It actually stood at $191 million for 2004. On top of this, the company can add to its savings kitty through a common corporate infrastructure, increased purchasing power with suppliers, increased coverage opportunities that represent upside to the above figure. And all of this comes before the new combined entity can explore new revenue opportunities. The caveat however is that how quickly and seamlessly can Sun integrate the company within its realms without creating a cultural clash.

Buying a tape storage company did not look very exciting or glamorous at the face of it. Borrowing from a cliché, there is more to it than meets the eye. Tape revenues are unlikely to grow at scorching rates but there's no question customers will store more data on tape next year than this. It continues to be the most economic electronic storage medium available today. Just talk to any CIO, and he will tell you that tape is about five times less expensive than spinning disks. And that's before you get to savings from lower power consumption and reduced cooling needs - the great beauty of not having to keep disks powered and cooled day and night. While Sun cannot deny that the storage marketplace will move towards virtualized storage systems but it expect tape to continue to play its role as the lowest cost media. And the
deep-rooted principle behind the same is that customers may migrate to better apps, faster computers, but they never let go of their data.

Organic growth and partnerships with industry leaders would not have been sufficient for Sun to exhibit substantial short-term improvement in the storage business. This acquisition satisfies the company’s quest for increased revenue, immediately enhances earnings, and brings a captive customer base and a fair amount of IP. Unlike earlier acquisitions this one also offers direct product revenue and revenue from the installed base in the form of services and consumable tape media. While the acquisition may not seem totally complementary, it brings benefits to the table that are worth the buck. Rather a whole lot of bucks that Sun shelled out.

And with this I rest my case. There is more than meets the eye!

This piece was never published, because I wrote this as part of a job interview for a Singapore based IT Analyst firm. And yes I did get the job!!