Update: Sun to Purchase Cobalt in $2 Billion Stock Deal

Updated from 12:01 p.m. EDT

Sun Microsystems(SUNW Quote) announced Tuesday that it would buy Cobalt Networks(COBT Quote), a maker of server appliance products, for stock valued at $2 billion.

Sun, which makes computer servers and workstations, said the deal would accelerate its move into the server appliance market. Server appliances act as engines for the delivery of network-based services.

Under the terms of the deal, Sun will exchange a half share of its common stock for each share of Cobalt. Based on Monday's closing prices, that would value each Cobalt share at $57.63, a 39.7% premium over Cobalt's price.

Sun Microsystems closed Tuesday regular trading up $2.48, or 2%, at $117.69. Cobalt Networks finished up $16.06, or 39%, at $57.19.

Shebly Seyrafi, an analyst for A.G. Edwards & Sons, said some investors have soured on the PC business and view server appliances as a large growth business.

"Sun is announcing to the world that it is going to adopt more of a buy than a build approach" to entering the market, said Seyrafi, who rates Sun shares a buy and whose firm has not performed underwriting for the company.

Seyrafi noted that the deal signals that Sun will at least address Linux, the operating system whose source code is open for alteration. Until now, Sun rival IBM(IBM Quote) has been quicker to adopt the system, he said.

But Ed Zander, Sun's president and chief operating officer, said, "We did not approach Cobalt with the word Linux on our forehead."

In a conference call with analysts Tuesday, Zander said Sun's primary interest in Cobalt was for its server appliances. "We're going to still confine our Linux offerings right now," he said.

Sun's competitors have also sought to enter the market for appliances, which has already grown rapidly since its recent inception. Since the devices are dedicated to one function apiece, like storage, email or Web-serving, they can be made inexpensively. In June 1999, IBM bought Whistle Communications, a Foster City, Calif.-based maker of appliance for electronic business. In a news release at the time, IBM never used the word appliance, instead calling Whistle a "leading 'thin-server' computing company."

Unlike many of its competitors, Sun, based in Palo Alto, Calif., designs the microprocessors for its own machines. Analysts expect the company to introduce Ultrasparc 3, a new line of microprocessors that will effectively change all the company's products, next week.

The purchase of Cobalt, based in Mountain View, Calif., puts Sun in a position to compete with Dell Computer(DELL Quote) and Compaq Computer(CPQ Quote), which have indicated that they will enter the appliance market as well.

Sun said it expects to complete the Cobalt acquisition during its second fiscal quarter, which ends Dec. 31. The company said the deal would add to its earnings before interest, taxes, depreciation, amortization and other items in the second half of fiscal 2001.

Cobalt made its initial public offering in November. The tiny, money-losing company with $13 million in sales scored what was the third-most-successful IPO at the time. Partly fueled by enthusiasm for the Linux operating system, the company's shares rose as high as $158 from $22.