Editor's note: This Stocks Under $10 alert was originally sent to subscribers Nov. 1 at 3:18 p.m. EST. It's being republished as a bonus for TheStreet.com and RealMoney.com readers. The author, Larsen Kusick, is part of TheStreet.com Stocks Under $10 Investment Team.
Being a large-cap is no guarantee of avoiding the under $10 bargain bin. In terms of market capitalization,
is one of the largest companies in the under $10 sector.
But even though shares once traded above $60, they have stalled around $5 for several years. So let's take an in-depth look to see whether Sun can reclaim part of its former glory and if shares are worth your investment dollars.
Sun was once considered one of the top names in the tech space. During the late 1990s and early 2000s, the company's sales skyrocketed as thousands of companies bought its servers. These high-performance computers drive a variety of applications, from providing email services to maintaining databases to serving Web pages, and are needed by a host of companies ranging from huge international corporations to small start-up businesses. In its heyday, Sun was known for its high-quality servers built on the Unix operating system and its market-leading technology.
But a severe slowdown hit Sun's business in late 2001 as many of its customers cut capital spending, migrated to less-expensive Windows- or Linux-based equipment, or simply collapsed. Many companies began to favor Linux, an open-source (freely distributed code that may be modified) operating system because of its lower associated costs and increased flexibility.
Sun had also been a major vendor to online businesses and Internet service providers (ISPs), which were some of the first casualties of the bursting tech bubble. Plus, the bankruptcy of many of its former customers created a double-whammy for Sun as its equipment flooded the resale market, pushing down pricing.
In recent years Sun's massive Unix systems have consistently lost market share to Windows- and Linux-based servers, forcing the company to reconsider its strategy. Customers found that "scaling out" -- buying many servers to fill individual roles -- is more cost-efficient than purchasing Sun's traditional "big iron" systems, which come with significant maintenance costs as well.
Today, Sun competes directly with
in its legacy server space, but the company has also developed its own flexible systems to meet customers' changing demands.
Sun also continues to have a number of revenue-producing channels, including its workstations and servers, its highly reputable Solaris operating system based on Unix, as well as complementary storage products. The company's recently completed 2006 fiscal year marks the first time Sun has posted positive revenue growth since its 2001 peak.
Nevertheless, a return to sales growth is nothing to get excited about as Sun's competitive position has weakened over the years. The company is no longer the highly regarded market leader in servers and faces stiff competition on several fronts.
The core problem for Sun is the ongoing commoditization of the server market. Although the company has historically focused on its higher-end markets, that strategy pitted Sun against heavyweights IBM and H-P in the market for more-expensive, higher-margin systems.
In order to drive sales growth, Sun's management expanded its strategy and now targets the lower-end server market as well, where it faces the high-quality but low-cost systems of
Sun's troubles in recent years stem from the company missing the boat as its addressable market began moving toward
-based systems running Linux or Windows. By ignoring customers' preference for cheaper and less-expensive-to-maintain systems, Sun is now playing catch-up, fighting for market share gains vs. Dell and others in lower-margin servers. Meanwhile, Sun is also fighting to maintain margins in its core, high-end Unix market, which is in a decline vs. the overall server market.
On the bright side, Sun's recent moves have been in the right direction. For the first quarter of fiscal 2007 (reported Oct. 26), Sun posted a loss of 2 cents a share on revenue of $3.19 billion, slightly ahead of consensus expectations for a per-share loss of 4 cents and revenue of $3.18 billion.
Highlights included 17% year-over-year growth in sales and management's statement that Sun is on track to achieve 4% operating margins by the end of fiscal 2007. Investors were generally pleased by the results, which helped push shares up to $5.50 from levels around $5.20 a week earlier.
This latest quarter illustrates the company's momentum in its turnaround efforts. Sales growth has been driven by Sun's success with its
Opteron-based Galaxy line for the x86 server market, which also boasts higher average sales prices and margins. Sun's Niagara platforms have also added nicely to sales, contributing more than $100 million in revenue in the most recent quarter.
The company's success has been marked by its refocus on superior technology -- offering products that are more energy-efficient, generate less heat and are smaller than competing systems. Rivals are following close behind, however, with their own Opteron-based systems. Finally, Wall Street analysts have praised management's cost-cutting efforts, citing the early stages of a dramatic turnaround for the company.
Given all this information, the question remains -- are shares of Sun a good investment?
For the Stocks Under $10 model portfolio, we don't believe that Sun shares offer the significant upside we look for in the under $10 universe. It's true that management has done a good job turning the business around, adapting to customer demand and refocusing on being a technology leader in the server market. Sun's highly regarded Unix-based operating system, Solaris, should also help the company keep pace in the top-tier server market.
But upside potential is limited in part due to the fact that Sun's core markets have matured and the company must now rely on its services segment to drive improvements in profit margins. The competitive landscape also leaves little room for outsized opportunities, as IBM, Dell and Hewlett-Packard are all entrenched companies with the resources to sustain long-term pricing pressure.
As a result, we see Sun's fortunes as being closely tied to capital spending in the tech sector. In addition, shares of Sun have advanced to the mid-$5 area since its earnings announcement last week, representing an advance of more than 40% from the summer lows around $3.80.
This is not to say that shares of Sun are overvalued or should be sold by current holders. But the risk/reward is not compelling enough for us to recommend a new position, especially relative to the potential return we aim for in the Stocks Under $10 model portfolio.
In keeping with TSC's editorial policy, Larsen Kusick doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Kusick is a research associate at TheStreet.com, where he works closely with Jim Cramer and works on TheStreet.com Stocks Under $10. Prior to joining TheStreet.com, he worked in options trading and management consulting. He appreciates your feedback;
to send him an email.
Interested in more writings from Larsen Kusick? Check out