Oracle Corporation and Sun Microsystems have entered into a definitive agreement under which Oracle will acquire Sun. The transaction is valued at approximately US$7.4 billion, or
US$5.6 billion net of Sun’s cash and debt.
According to Springboard Research, the Asia Pacific is an important market for both Oracle and Sun. As per the latest available data, the region accounts for roughly 15% and 18% of global revenue for Oracle and Sun, respectively, for a total of over US$5 billion.
The research firm has released an in-depth focal point article on the acquisition and has listed a summary of their key observations 24 hours after the announcement.
The 10 Key Observations are:
The IT Industry Landscape Has Just Been Fundamentally Altered
By any measure or calculation, it is clear that this acquisition will reverberate throughout the global IT industry. The combined company has annual revenues in excess of US$35 billion, making it one of the largest and most diversified IT companies in the world. The implications for customers, competitors and channel partners are systemic and permanent.
Moreover, this deal is yet another clear indication of ongoing consolidation in the IT market. At its most basic level, it appears that via the Sun acquisition, Oracle is positioning itself to compete far more effectively with IBM in terms of both breadth and depth of its enterprise software solutions. IBM’s earlier interest in Sun was clearly driven by a desire by IBM to benefit from ongoing server OS market consolidation, improved economies of scale, and the elimination of a competitor. Oracle’s interest in Sun is not nearly as straightforward, and the implications of this deal are more disruptive to the industry than if Sun had “melted” into Big Blue.
Oracle’s Long-Term Commitment to Hardware is Questionable
The extent to which Oracle is committed to competing in the hardware market remains to be seen. Oracle has operated as a software business since its inception, and diving into the hardware market will bring a myriad of new challenges. This is especially true considering the challenges that drove Sun to pursue acquisition partners so actively over the past year.
If Oracle decides to retain Sun’s hardware operations in the long term, there are many questions about how successfully the company will be able to compete in this market. Margins in the hardware market are nowhere near those in the software industry, and price erosion as well as slower market growth make this segment a less attractive market space in pure financial terms. Nevertheless, what is clear to Springboard is that a high degree of autonomy will be required for the hardware division if Oracle is to succeed in this market.
It is also possible that Oracle will not retain Sun’s full hardware business and will instead seek to sell off the server, storage and chip business to someone else and remain focused on enterprise software. As long as Oracle retains Solaris, then “ownership” of the server and storage hardware is not particularly relevant. Oracle could therefore be better off selling this division given the company’s lack of hardware-related focus, expertise or experience, and the fact that margins in this area are far below what Oracle is accustomed to in the enterprise software space.
Finally, R&D is critical in this market, particularly given the investments by IBM and HP in their systems R&D. Oracle has tended to acquire R&D, but will need to ensure that legacy Sun systems get adequate support in terms of R&D to allow product development to maintain its competitive edge.
The Data Center is a New Battleground
Over the past four weeks, the data center has become a particularly dynamic new battleground for the world’s leading IT providers. Long dominated by IBM, HP, Dell and Sun, the market now has two new formidable competitors in Cisco and Oracle. These moves have rattled IBM, HP and Dell, and will lead to a more active and competitive market.
From a data center perspective, Springboard believe Oracle is actually pursuing a somewhat contrarian strategy. As standards have evolved and matured over the last decade, a services-based approach to application design and delivery has made the underlying implementation platform (including server operating systems and hardware) less important as a central design point. Steady growth in open source has driven acceleration in the trend toward standardization and ultimately commoditization at the software infrastructure layer. Finally, virtualization and more recently, cloud computing, have added additional layers of abstraction or separation between applications or application services and the underlying hardware or platform.
Combined, these trends would indicate that organizations are less likely to seek an “all-inone” solution from one vendor. However, by touting the benefits of an “integrated platform” as a key rationale for seeking this deal, Oracle is clearly betting that an integrated platform is indeed something customers will value.
Considerable Implications for Industry Partnering and Alliances
Partner and alliance managers, particularly those at IBM and HP, are going to be significantly impacted. Clearly their priority will be challenged by this acquisition. It is unlikely that IBM and HP will aggressively push any hardware-software bundle that impacts their own hardware business. In the long term, Oracle will have to look beyond traditional go-to-market models and more innovative alliances if it is looking at offering a bundle of Oracle-Sun offerings.
Sun has always employed a more partner-led model than Oracle, which is famous for its active and successful direct sales force. We believe Sun’s hardware channels and SIs will likely be threatened by Oracle’s direct sales team. It will be important for Oracle to ensure that it does not disrupt Sun’s channel partners with an overly aggressive sales force; doing so will risk losing successful and dedicated channels to competitors such as IBM and HP.
A key benefit Oracle will receive from this acquisition is greater clout and influence with ISVs and developers. Sun has a highly committed and passionate developer community that is drawn to its platform. The Oracle acquisition will provide the new company with a stronger position within this critical community, which will present a stiffer challenge to Microsoft, IBM and SAP within this constituency.
Oracle is No Longer a Cloud Computing “Also-Ran”
Oracle can quickly go from being an “also-ran” in the cloud computing space to a leader by leveraging Sun’s recently announced Sun Open Cloud Platform, which is based on Java, MySQL, OpenSolaris and Open Storage (all of which are technologies and/or solutions that Oracle will likely leverage significantly moving forward). In fact, Springboard expects Oracle to move quickly in this area, particularly given its early emphasis on the synergies between Oracle’s strength in enterprise software and Sun’s strength in mission-critical computing systems, and its initial positioning as the only company capable of delivering integrated systems that extend from “applications to disk.”
Consulting and Integration Will Need Work
Both Oracle and Sun have historically relied upon partners for a considerable proportion of services delivery, particularly from the point of view of consulting and integration. However, if the acquisition has genuinely provided Oracle with an end-to-end solution with and far less “hardware agnosticism”, it must develop strong services capabilities across the maintenance, management and consulting areas.
The question then is who will provide these services. The three largest IT services providers are IBM, HP and Accenture. All three have reasons to not be the integrator of choice for Oracle. IBM and HP have clear competitive hardware issues, and Accenture obtains a significantly larger proportion of revenue from SAP integration and management than Oracle and is committed to providing multi-vendor support. The next tier of services providers are difficult to match up. Some are too regionally and SAP-focused (Fujitsu and Cap Gemini). CSC has a strong Oracle practice, but is more linked to an IBM platform than to Sun.
While it might be a lateral play, Springboard says that it will not be surprised to see Oracle identify someone such as TCS or Infosys to support them in terms of services. Whether this is through acquisition or otherwise is largely a moot point. Oracle will need to do something to quickly build or buy capability.
Acquisition Brings a Treasure Chest of Complementary Software Technologies
Following closely on the heels of last year’s BEA acquisition, Oracle now clearly has some massive integration hurdles to overcome as it seeks to rationalize its enterprise software infrastructure portfolio. However, the overlap in software products and technology between Oracle and Sun presents a very different set of challenges relative to the BEA portfolio. Where BEA’s portfolio was in almost every respect directly competitive with Oracle’s Fusion Middleware, Sun’s portfolio is in many key ways complementary to Oracle’s core strengths in databases, enterprise applications and middleware.
The best example of complementary technology from Sun is Java, which is the foundation for Oracle’s entire Fusion Middleware stack (and therefore also the foundation for the Oracle E-Business Suite of enterprise applications). Sun was never able to effectively monetize Java, which impacted the company’s approach to controlling the platform’s evolution, particularly via the Java Community Process (JCP). Since Oracle has not suffered the same problem, we expect the company to likely expand Java-related collaboration with other major software infrastructure vendors, including competitors like IBM, and focus instead on improving its own Java-based solutions as its basis for competition and growth in this area.
While in some respects, MySQL represents an alternative to Oracle’s core database, Sun’s,MySQL open source database is also complementary to Oracle 11g and will give Oracle, access to a large open source developer community and broader presence in the web applications market, where MySQL is embedded. Oracle’s history with Innobase, an open source database the company acquired in late 2005, suggests that Oracle is more likely to embrace the open source database market and seek further synergies with its commercial database offerings (including up-sell opportunities) versus seeking to kill off a potential threat due to fears of cannibalization.
The future of Sun’s Solaris operating system is less clear cut. Oracle will clearly seek synergies with Solaris and bundling opportunities, particularly since Solaris is so critical as an underlying platform for Oracle database sales. In terms of future direction, however, Sun has invested great effort over the past several years to position Solaris as a viable competitor to Linux by releasing the source code via the OpenSolaris project. Over this same period, Oracle has made major investments in Linux (and Linux support services in particular), via its Unbreakable Linux initiative, which competes directly with Red Hat.
Oracle will need to reconcile these conflicting strategies and lay out a clear OS vision in the near future.
Maintenance Revenue is an Important Component
Over the past 4-5 years, Oracle has done a remarkable job acquiring companies that provide solid growth potential (including up-sell and cross-sell opportunities) while also delivering very strong maintenance revenue streams. The proposed Sun acquisition fits perfectly into this pattern, with Oracle buying a base of blue chip clients tied to the Sun platform and roadmap. This maintenance revenue stream is a hedge against acquisition risk and an annuity to deliver financial benefits.
The Financial Payback for Oracle Will Be Favorable
Oracle’s acquisition strategy has been criticized – often vehemently by competitors – but even the harshest critics have a hard time finding fault with the financial returns of the firm’s acquisitions over the past five years. Oracle bought Sun for well below one-half its revenues (adding in Sun’s net cash and debt), while estimating that Sun will “contribute over $1.5 billion to Oracle’s non-GAAP operating profit in the first year, increasing to over $2 billion in the second year.” In Springboard’s estimation, this is a positive financial deal for Oracle that will pay for itself, in part due to the lack of technology and product offering overlap that could have derailed deals with IBM, HP and Cisco.
In spite of the value Springboard sees in this deal for Oracle and the financial returns anticipated, Springboard emphasizes that Oracle must still clarify how hardware factors into the company’s long-term plans. Hardware represents the largest share of Sun’s revenues, so how Oracle plans to maintain and then grow this part of Sun’s business is a critical and open question.
Expect More Acquisitions in the Industry
Springboard expects this move to spark accelerated M&As in the industry, which will lead to several firms getting caught in the middle or left out. Oracle’s move shows that there might be many more such possibilities in the technology industry. While Sun was facing challenging times well before the economic downturn, there are likely other big technology companies who will be looking for new alliances and partnerships via mergers or acquisitions. Some of these mergers or acquisitions could be completely out of the box or radical enough to confound everyone in the industry, very much like Oracle’s move did.
More than ever before in recent memory, Springboard sees the next 12-24 months as a particularly pivotal point of transition for the competitive makeup of the IT industry. Current market valuations and company challenges present IT companies with ripe conditions for strategic acquisitions. When combined with some of the fundamental shifts taking place in computing models – with virtualization, could computing and SaaS most noteworthy among them – it is clear to Springboard that the industry is at a point where IT leaders need to have a sound M&A strategy and ability to execute for long term success.
Companies Springboard expects to be key players in these discussions looking forward include IBM, EMC, Cisco, HP, Dell, NetApp, Juniper, Google, Salesforce.com and of course Oracle.
Conclusion
Like all acquisitions, the success of the Oracle and Sun marriage will depend on integration and execution. If it is executed correctly, it will change the dynamics of IT in substantial ways, from partner-based selling to end-to-end stacks.
Nevertheless, Oracle will encounter stumbling blocks if integration and execution falter. Springboard remains uncertain about the future of hardware within the new company and the firm’s ability to succeed in this market.
Other potential pitfalls in their view include the business partner disruptions it could cause and an inadequate consulting and integration capability to bring Oracle’s promising technologies to the market.
Another dynamic we will be monitoring closely is Oracle’s ability to evolve its organizational culture as it becomes a larger and more diversified company. Oracle has one of the industry’s clearest and most identifiable cultures. Like its founder, Oracle is confident, assertive, bold and aggressive. Although positive as core cultural components, Springboard believes Oracle will need to augment and diversify its culture as well as its business. By taking the best of Sun – especially R&D and partnering excellence – Oracle can strengthen itself.
Springboard believes that the positives outweigh the negatives with this acquisition and that IBM, HP, Microsoft, SAP and Cisco now have a more formidable enterprise computing competitor before them. In spite of the risks, Springboard says that this acquisition is indeed a bold stroke that will disrupt the market and force competitors to adapt quickly, for those that fail to do so could be headed for trouble.
Condensed from a Springboard Research Focus Point article. The complete version of this document is available for free download from http://researchcentral.springboardresearch.com
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