UBS review of Sun Microsystems

July 29, 2005

View from Silicon Valley- UBS review of Sun Microsystems

Silicon Valley may be famous for its geeks and technical savvy but, based on the dumbed down local news reports we hear, financial expertise is assumed to be lacking. (And we're not just saying that because the median house is up 53%+ in the last 18 months while the number of employed residents is down over -5%.)

Occasionally, we get exposed to Wall Street research. We like to read it, hoping it will help cut through the pablum and cheerleading we get locally. Sometimes this research is on companies we like to think we know something about. We also recognize a couple of fairly famous quotes apply to any tout on a stock, perhaps doubly so for Wall Street research:

“When you sit at the business table you always look for the sucker or fool. If you don’t see one, it’s you.” (Attributed by Mark Cuban to his friend "Andy")

-and-

"Never put your money in something where you don't have an information advantage." (Mark Cuban)

These comments leapt to mind after reading a recent review on Sun Microsystems by UBS. Driving by rows and rows of "see through" office buildings every day, we feel like we know something New York-based analysts do not --if you are below the "C-level" in Silicon Valley, the economy is still weak. Thousands and thousands of formerly well-paid, fully-employed engineers and technicians are still hoping for a "recovery."

(Contact editor for copy of original report...)

Servers use tons of memory. Compared to a PC, a server is an absolute memory hog. However, even with memory component prices crashing last quarter, SUNW margins were flat, which might be considered an improvement after three straight quarters of decline.

SUNW "earned" +$0.06-- if you count +$0.08 from changes in their tax accounting. If sales STILL don't pick up next quarter, presumably Sun can change their accounting for intangibles, followed by depreciation, R&D, inventory, facilities, etc. Barring a complete disaster, their accountants will always make sure Sun meets "the number." (Apply this logic to companies which sometimes actually grow sales and decide how much you should be investing based on any of these numbers...)

If the accounting maneuvers start to run out, we expect SUNW will "re-organize," putting a different group of insiders and vested interests in charge of tilting at a new windmill. The re-organization will tragically require SUNW to take a loss by charging themselves with a big loss reserve. This reserve will have the convenient side effect of creating a new happy hunting ground for new accounting gimmicks so that the cycle can start all over again.

Don't be fooled by apologists (err, "analysts") pointing out Sun has a lot of cash in the bank. Yes, thanks in small part to a large "donation" by Microsoft last year, Sun still has $3.4B in cash (~$1 per share) with little debt. However, outside of over-paying for a marginally-performing company with a similar lack of growth prospects (Storage Tech), and funding stock options awarded to employees, they can't seem to find anything to do with this resource.

Heaven forbid Sun should change the business model or scale down costs in reaction to 12 consecutive quarters of operating losses and four (4) straight years of declining sales revenue. Nowhere else in publicly-traded stocks, and even at darn few cult technology stocks, would such miserable management performance be tolerated.

UBS guesses the stock might tick up 7% over the next 12 months. They base this pontification on observing SUNW has a sub-1.0 EnterpriseValue-to-Sales multiple and "Sun's 10-year range" for this figure bottoms out around 1.0. Note to UBS, this is a really(!) obscure statistic to cite as justification for a stock to go up. Even so, forecasting SUNW's stock price based on an EV/S, or any stat, which includes the boom years is sticking your head in the sand over their deeply flawed business model which has seen sales decline 40% over the last four years.

Bottom line, UBS rates SUNW "neutral." Based on a review of recent Zacks data, this is at the high end of current analyst opinions.

Conclusion: Barring a miracle, or the removal of management (which would qualify as a miracle), not much is likely to change at SUNW. The hard facts we can dig up, coupled with what we see driving around Silicon Valley, suggests SUNW is likely to be lower before it gets much higher. Maybe that's what "neutral" means at UBS? Could you tell that from reading their report? Me neither...