Wednesday, March 18, 2009


I.B.M. is in talks to buy Sun Microsystems in a proposed deal valued at nearly $7 billion, a person with knowledge of the negotiations said on Wednesday.

The merger, if completed, would be a major consolidation in the market for server computers used in corporate data centers — and one that could prompt an antitrust challenge.

For I.B.M., the move would be something of a departure from its successful strategy of paring its dependence on the hardware business, where profit margins have declined, and increasing its investment in higher-margin software and services businesses.

But the combination of I.B.M. and Sun, analysts say, would bring together two technology companies that have continued to invest heavily in research and development, when many of their corporate peers have cut back to shield profits. I.B.M.’s research and development budget is about $6 billion a year, while Sun’s is roughly $3 billion.

I.B.M. has spent generously on research at a time it is thriving. Sun, however, has struggled financially, and its high operating costs, including research and development, have been criticized by Wall Street analysts.

The proposed price for Sun is worth roughly $10 a share. At midday Sun’s stock was up $4.10, or 82 percent, to $9.01.

If its bid for Sun succeeds, the deal would be the largest in I.B.M.’s history. The company has mostly shunned costly purchases, preferring instead to engineer a series of smaller deals to fill in technologically strategic niches in its software business or add to its skills in services.

To date, I.B.M.’s largest acquisitions were the $4.9 billion it paid for Cognos, a business intelligence software company, in 2008, and the $3.9 billion it paid for PricewaterhouseCoopers in 2002, which greatly enlarged Big Blue’s services business.

News of the talks between the two companies was first reported by The Wall Street Journal. I.B.M. would not comment. Sun’s chairman, Scott McNealy, said in an e-mail message: “As always, I don’t comment on rumors, no matter how accurate or silly they may be.”

In Sun, I.B.M. would be picking up a company with a heritage of innovation not only in hardware, but also in software. Sun created both the Solaris operating system, a version of Unix, and the Java Internet programming language and software tools. Java is the teaching language in most of computer science, and software programs written in Java are widely used in everything from corporate data centers to cellphones.

An estimated one million software developers write applications on Sun’s software platforms, while I.B.M. vast software business claims eight million developers in its camp. I.B.M. has been a big supporter of Java, and both companies are backers of the open-source Linux operating system, a rival to Microsoft’s Windows in data centers and on some desktop personal computers. In 2008, Sun increased its commitment to open-source software by paying roughly $1 billion for MySQL, a company distributing an open-source database that is widely used in Web commerce sites.

But unlike I.B.M., Sun has found it difficult to enlarge its software business enough to take over as a growth engine from its hardware business. Late last year, two people with knowledge of the talks said, Sun began meeting with representatives of other technology companies about selling itself.

Sun has strong ties to large customer groups that appeal to I.B.M., like telecommunications companies and government agencies.

Sun, under Mr. McNealy and its chief executive, Jonathan Schwartz, has held onto its heritage of innovation and research in recent years. But that commitment has held back its profits, and the spending has been frequently criticized by Wall Street analysts.

Even today, Sun’s gross profit margins are more than 40 percent, but its operating profits have been close to zero in recent years, said A. M. Sacconaghi, an analyst at Sanford C. Bernstein.

“I.B.M. should be able to improve the margins, given the overlap in businesses and overhead expenses in these two companies,” he said.

I.B.M. could add the MySQL technology, which is popular with Internet companies, to its own DB2 database and gain a larger share of one of the most lucrative parts of the software market.

In addition, Sun has tried to revitalize its storage line through new software and hardware — both of which would help I.B.M. compete against H.P. and EMC.

I.B.M. would inherit Sun’s networking technology, including a new line of switches. That technology looks more crucial following Cisco Systems’ entry this week into the server market and H.P.’s decision to invest more in its networking technology. Cisco acquired I.B.M.’s networking business in 1999. But by acquiring Sun, I.B.M. would also be making a big investment in a business — computer servers — that has not shown much overall growth in recent years, and must withstand the relentless force of commoditizing cost pressure in the hardware market.

I.B.M. sold its personal computer business to Lenovo of China for $1.75 billion in 2005, and its hard-disk drive business to Hitachi of Japan for $2.05 billion in 2003.

In the server market, the I.B.M. move seems to be a straightforward consolidation tactic, and one that could bring antitrust scrutiny.

Together, I.B.M. and Sun would have about 65 percent of the market for server computers running the Unix operating system and 42 percent of the total server market, measured in the dollar value of the market.

In the Unix market, there would really be only one other significant competitor, H.P.

Still, the recent volume growth in the server market has come mainly in machines run by lower-cost microprocessors, made by Intel and Advanced Micro Devices, using personal computer technology.

The key antitrust issue in reviewing the proposed deal, legal experts say, will be how regulators define the server market. If the market is viewed as including technology beyond Unix servers, the antitrust hurdle will be considerably lower, they said.