IBM is reportedly in talks to acquire hardware/software competitor Sun Microsystems for between 6.5 and 7 billion. Both The Wall Street Journal, which broke the news Wednesday, and The New York Times cite sources familiar with the negotiation but neither IBM nor Sun have confirmed the news.

A merger would consolidate the first and fourth-largest server providers in the IT hardware industry based on revenue. While server sales have fallen overall, Gartner Inc.’s Q4 2008 report showed IBM with a 33.4 percent market share and Sun with 9.6 percent. The second and third-largest server shares belong to HP (30 percent) and Dell (10.7 percent).

With internal reorganizations failing to turn the tide of declining revenues, Sun has been the subject of acquisition rumors before, which have included HP as a possible buyer. “Sun was focused too much on their core market of high-end servers and when the market shifted to the low-cost Intel platform they were kind of blindsided,” says Ed Maguire, an industry consultant and market analyst at MagNet Strategies, LLC. “Plus, their moves into software haven’t made a lot of sense and they’ve never made money there.”

While IBM and Sun factor heavily in the hardware market, a merger would also carry wide implications for the software and services market where IBM has increasingly focused.

Ian Finley, an analyst at AMR Research, says hardware is less than half of what’s on the table. “Fifty-seven percent of IBM’s revenue comes from services and 82 percent of their margin last year came from software and services. That part of the company is really beginning to run things.”

More interesting to Finley is what could result if IBM becomes the steward for Sun’s Java programming language. “IBM already has WebSphere and a whole bunch of services businesses tied up around Java. If IBM ‘controls’ Java, they could drive a lot of high-margin business that would have gone to Oracle or Accenture or somebody else that will dwarf the impact of the hardware.”

Competitors including SAP and Oracle have been building middleware and applications with Java at the foundation, which might spur an antitrust suit, Finley says, since so much of the world’s infrastructure depends on Java. “When Sun was running it, it was okay because Sun was unable to monetize it. Now you give it to IBM with their sales and service channels and all of a sudden it looks scary.”

Dan Kuznetzky, principal analyst and president of Kuznetzky Group LLC, sees less sense in the deal and warns a cultural gap could eventually undue the intellectual capital at stake in a merger. “At IBM, people dress in suits and if you’ve ever visited the Sun campus you see mostly business-casual to ponytails, a lot of techies. If you put those companies together, the technical giants you’d want to preserve might not stay and you wind up with a shell of a company. IBM did that once already with [1984 telecom acquisition] ROLM.”

Plus, Kuznetsky says, IBM already owns a dominant share of the same types of products Sun brings to market and could get what else it needs through partnerships rather than acquisition.

But Sun’s share price has fallen about 70 percent in the last year and Maguire says the board of directors has likely seen the writing on the wall. “Eleven bucks a share would be a great outcome for Sun shareholders, and for IBM this is a great time to put cash to work,” he says. “Sun’s trailing 12-month revenues are about $13.3 billion and, accounting for cash and debt, an enterprise valuation to sales valuation of 0.5 has to be pretty attractive. At $6.5 or even $8 billion it’s still an attractive valuation and I imagine the shareholders would jump at it.”

The deal would be the largest in IBM’s history, though the company did pay nearly $5 billion in its acquisition of business intelligence specialist Cognos which closed last year.

Additional coverage on this story is available at Insurance Networking News.

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