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IBM Could Suffer Sun Damage

For IBM, swallowing Sun could be easier said than done


(IBM) - Get Report



to buy

Sun Microsystems


may be

music to the ears

of Sun's investors, but the jury is still out on whether a deal would be good news for IBM shareholders.

Whereas Sun's stock exploded on the

M&A talk

, rising more than 77%, IBM's shares fell 2.32%, despite a broad rally in tech stocks that saw the Nasdaq rise 0.64%.

Although an acquisition would undoubtedly create an enterprise IT behemoth, IBM needs to carefully consider the impact of buying Sun, according to Goldman Sachs analyst David Bailey.

"We would question the short-term and longer-term benefit to IBM from a potential combination," he wrote in a note released Wednesday. "While there would undoubtedly be significant cost savings in the hardware divisions of both companies post a potential acquisition, there is also substantial overlap in almost all product lines."

Perhaps the biggest challenge for IBM, however, is taking care of the execution problems that have hampered Sun in recent years. The Santa Clara, Calif.-based firm, for example, struggled to swallow its acquisition of StorageTek in 2005 and is seen as one of the tech sector's big underachievers.

Despite repeated attempts by Sun's management to put its house in order, the company's stock has been in retreat for months, and the firm's revenue tumbled 11% year over year in its recent second-quarter results.

Sun's business model is less resilient than that of IBM, which has largely avoided the worst of the global economic crisis, partly thanks to its software and


businesses. Whereas IBM can depend on these recession-resistant divisions for revenue, Sun typically relies on a more traditional business model, according to Bailey.

"This would increase IBM's exposure to transactional business, reversing an effort by IBM over the past decade to increase its recurring revenue streams," wrote the analyst.

With Sun and IBM already competing in areas such as servers and storage, the combined company could become a complex Gordian knot with overlapping business units vying for dominance. To make matters worse, Sun could also increase IBM's exposure to the slowdown in financial sector spending, which has already

hammered its own revenue


Despite these challenges, it's not all doom and gloom. IBM's potential acquisition of Sun would offer plenty of


, most notably related to Sun's

TST Recommends

Solaris operating system


"IBM wins a customer base that did not prefer them," said a tech industry executive, who asked not to be named. "There's a lot of Solaris out there in oil and gas, telecom and government -- these are all areas where IBM has typically not been the strongest."

The executive explained that Sun has an "enormously valuable" asset in its open-source software stack, but has never been able to truly monetize this. Contrast Sun with IBM, he added, which has made money out of running Linux on mainframe technology.

"Take all that intellectual property that Sun has, and graft it onto IBM's model and that's a winner," explained the executive. "IBM knows how to execute."

The Armonk, N.Y.-based firm would also inherit the MySQL database technology which Sun bought for a billion dollars last year, but has not yet turned into a major source of revenue. Big Blue could use Sun to beef up its

cloud computing strategy

, potentially strengthening its arm against the likes of


(AMZN) - Get Report



(GOOG) - Get Report


Talk of an IBM/Sun acquisition also reflects the

shifting nature

of the tech sector. On Monday, for example, networking firm

Cisco Systems

(CSCO) - Get Report

made its first foray into the server space, and IBM rival


(HPQ) - Get Report

is also ramping up its portfolio of switch products.

By snapping up Sun, IBM would remove one competitor from the market, and potentially bolster its ability to withstand challenges from the likes of Cisco and H-P. IBM may also be exploiting the tough economy to get hold of Sun's IP at a bargain price.

Citing unnamed sources, the

Wall Street Journal

reports that IBM may pay up to $6.5 billion for Sun, which paid almost two-thirds of that amount to buy storage specialist StorageTek in 2005. Whether this proves to be a bargain or a bust would depend on how quickly IBM can turn its troubled rival around.