Oracle, Sun Now Face Integration Challenge

This story was written by CNET's Stephen Shankland.

The all-cash acquisition agreement - announced Monday, costing Oracle $5.6 billion with Sun's cash factored in, and expected to close this summer - puts the innovative but financially bumbling Sun out of its misery after IBM's move to buy it fell apart earlier in April. The way to fit Sun's technology into Oracle's business model goes back to a project called Raw Iron that's more than a decade old.

Raw Iron ideas placed application software front and center while demoting the server hardware itself and the operating system to a subordinate role. The customer who needs some database software need hardly know what's going on under the covers.

What's smart about the approach is that it lets Oracle profit from Sun's diverse technology - which includes not just servers but also open-source software including Java and the MySQL database that Oracle already tried to buy years ago - without disrupting its own business too much.

Oracle signed a Raw Iron partnership with Dell and worked on it with Sun, IBM, and then-independent Compaq. With Sun's technology in house, one major challenge of those deals - who's in the driver's seat--evaporates with Sun a part of Oracle. There's no longer any question about which partner owns the customer relationship, which services the technical support contracts, and how the sales revenue is divvied up.

Will server appliances work this time?

Here's the rub, though. Raw Iron, along with the related concept of server appliances that arrived a few years later, was a marketplace dud.

Customers appreciate integrated technology to an extent, but Raw Iron and server appliances quietly submerged beneath the waves. Also worrisome for Oracle is the failure of one of its integration ideas, Unbreakable Linux. Customers by and large ignored this Oracle attempt to offer its own version of Linux, a clone of market-leading Red Hat's product.

Oracle Chief Executive Larry Ellison is a true believer, though, making the sales pitch in the company's official statement:

"Oracle will be the only company that can engineer an integrated system - applications to disk - where all the pieces fit and work together so customers do not have to do it themselves," Ellison said. "Our customers benefit as their systems integration costs go down while system performance, reliability, and security go up."

He does have a point. Sun has always focused centrally on the database market, and it has compelling technology assets for it that it hasn't been able to sell effectively: its current Niagara and the delayed higher-end Rock multicore processors, its Solaris operating system, and its Thumper storage servers with tremendous built-in data capacity.

And selling products at this high level of integration gives Oracle a way to ingest Sun's considerable open-source assets - among them Java, MySQL, Solaris, GlassFish, NetBeans - without too much indigestion. It might even give Oracle some incentive to be more active with the open-source community it's mostly kept at arms' length.

The once and future server market

Another issue, though, is that server appliances are to an extent an artifact from an earlier era, when companies bought and managed discrete systems. That remains a big business, but it's at odds with two important trends gaining steam in the industry.

First is virtualization, chiefly through EMC's VMware software. This lets a single server run multiple operating systems, with the software collection moving flexibly from one physical machine to another as work load demands shifted. By breaking the hard link between hardware and software, virtualization undermines the integration sales pitch and inserts a third party's technology between the server and its higher-level software.

Second is cloud computing, where applications run on central servers on the Internet rather than in a company's own confines. Cloud computing takes many forms, but from Oracle's perspective, an excellent example is Salesforce.com, whose sizable cloud-computing service competes directly with Oracle's Siebel business for customer relationship management chores such as tracking who bought what and when their warranty is up for renewal.

But having Sun's hardware assets in-house gives Oracle more flexibility to adapt to cloud computing on its own, in particular through Sun's recently relaunched Network.com cloud computing infrastructure.

Financial complications

Sun Chairman and co-founder Scott McNealy and even more so CEO Jonathan Schwartz likely are breathing a sigh of relief. Sun's stock plunged after IBM's attempted acquisition of Sun fell apart, but with an Oracle acquisition offer also on the table, it's now clear why Sun could play chicken with IBM then issue a statement about the board's faith in Schwartz after IBM walked. On Monday, Sun's stock surged 36 percent to $9.07 in mid-morning trading.

Oracle seemed eager to justify the price, arguing it will improve Oracle's earnings per share significantly and that it will help the company more than earlier massive acquisitions.

"We expect this acquisition to be accretive to Oracle's earnings by at least 15 cents on a non-GAAP basis in the first full year after closing," Oracle President Safra Catz said in a statement. "We estimate that the acquired business will contribute over $1.5 billion to Oracle's non-GAAP (generally accepted accounting principles) operating profit in the first year, increasing to over $2 billion in the second year. This would make the Sun acquisition more profitable in per-share contribution in the first year than we had planned for the acquisitions of BEA, PeopleSoft, and Siebel combined."

It should be noted that although Oracle did surprisingly well integrating BEA Systems, PeopleSoft, and Siebel - despite having its own directly competing products in each case - but also that those were software companies. Sun is much more, and the future of its hardware business is cloudy.

Standalone server sales? At Oracle?

Oracle can sell software-hardware package deals and build a Sun-based cloud service, but how well will it serve customers who want to run their own machines with their own software? It's likely those companies will look elsewhere unless Oracle can show it truly wants to be a full-fledged hardware company.

It's not clear how much Oracle's financial projections rely on the strength of that standalone server business. Historically, selling software has much nicer profit margins. It's also not clear how much of a hit Oracle is expecting to its current software business after a Sun acquisition turns present allies into rivals.

Oracle also must deal with the fact that server makers Hewlett-Packard,
Dell, and IBM could become less eager to promote Oracle's software. Because massive database servers are so complicated, Oracle has relied on tight sales, support, and marketing partnerships, and those companies could lose enthusiasm if their server sales force starts seeing Oracle's offering competitive bids.

At least Oracle's acquisition faces less of an antitrust hurdle than IBM's. Big Blue and Microsoft offer viable database competitors to Oracle's and Sun's, and Oracle buying Sun mean there would still be major server makers rather than the three left standing had an IBM acquisition gone ahead.

So Sun shareholders and government officials likely will be convinced of the merits of the deal. The ultimate success, however, will depend on how Sun and Oracle's customers see it.
By Stephen Shankland