Sun Microsystems

Group 4: Joseph Trampis Gage BonJorn, Emily Lauren Feller, Danielle Rae Imbrigiotta, Clervenie
Michel, and Jensine Varghese
I. Case Summary
Oracle was born in 1977 from founders Larry Ellison, Bob Miner, and Ed Oates when they left
Ampex Inc. The first early adopters of their relationship database management system (RDBMS) were
clients such as government agencies such as the U.S Central Intelligence Agency and innovative
businesses. Throughout the 1970s, Oracle was able to capitalize on U.S corporations record keeping
needs. By 2009, all large U.S corporations were using data management systems in every aspect of their
business from back office to the Internet. Oracle was able to specialize in something no company had
done before by creating an easily accessible place to house the data and providing tools to search through
it. The ability to have your payroll, sales, supply chain reimbursements, and travel reimbursements all on
one system solidified its stronghold as the premier platform for RDBMS.
Oracle’s decision to go public in 1986 was able to happen based on Ellison’s confidence in the
future in this company. He had a vision to create a company that would dominate the “desktop of business
users'' market. For a brief period, Ellison was the wealthiest man in the world and by 2000 Oracle's sales
had topped $10 billion. These healthy profits allowed Oracle to accumulate cash which inturn allowed it
to become a serial acquirer.
Sun Microsystems was established in 1982 by three Stanford graduates who built desktop
computers and workstations. Sun's success was similar to Oracle due to its groundbreaking UNIX- based
Solaris which made its computers compatible with many other software and hardware computers. The
Solaris operating system was able to compete against Microsoft Windows in the corporate world and was
preferred by many. Sun went public in 1986 with a product offering dominated by its hardware sales. In
1995, the company developed the Java programming language which soon became the standard for
developing software applications. However during the late 1990’s due to an altercation with Microsoft it
was forced to make Java and Solaris free to its users. The economic downturn due to the dot com bust and
loss of sales led to Sun realizing they were going to need a financial bailout.
Ellison noticed an opportunity for Sun to be incorporated with Oracle and had an ability
to capitalize on Sun’s misfortunes. On March 12, 2009 Oracle contacted Sun about acquiring some assets
however IBM was also interested in Sun and soon Dell, Apple, Intel, and Hewlett-Packard (HP). The
main goal of this case was to assess if Sun Microsystems' deal with Oracle was beneficial. The goal of
Oracle was to make sure their valuation of Sun was correct so they could not be hasty in their decision.
We look at their ways of valuing Sun and their decision to use a conservative approach.
Case Questions
 A. Is Sun Microsystems a good strategic fit for Oracle?
As Sun Microsystem needed to find a way to save their business from their downturn in 2007,
Oracle was in a very good position to acquire them after looking at their business. The issue that arose
was that Oracle and Sun Microsystems were in the technology industry. Oracle specialized in software
and Sun Microsystems specialized in hardware. By the 2000s, Oracle was a billion dollar company and
was known as the premier platform for almost every corporation across the United States. The database
system allowed companies to have their payroll, sales, supply chain reimbursements, and travel
reimbursements all on one system, making it one of the most vital systems. The acquisition of Sun
Microystem’s hardware allowed Oracle to expand their reach and offer a wider ray of options to their
customers and expand their own portfolio.
B. What approaches would you use to place a value on Sun Microsystems?
In order to value SinMicrosystems, Oracle will assemble a team of valuation experts to calculate
the market value of the target firm while also determining if any synergies should be included in the
calculation. With this information, we will be valuing SunMicrosystems using the DCF model. The DCF
model will allow Oracle to estimate free cash flows available to the firm, discounted using the weighted
average cost of capital.
C. Assuming a discounted cash flow valuation:
1. What rate of return should Oracle require on the acquisition?
The rate of return is calculated using the weighted average cost of capital formula.
WACC ¿ r d∗wd∗(1−T )+ ℜ∗we=11.92 % ❑
The following are the inputs used for this calculation and our justification for such numbers

T = Tax Rate 28.6% Exhibit 13 (eff T. for 2007)

rd = Cost of Debt 11.42% Exhibit 9 & 10 (Ba1/BB+ Rating)

wd = Weight of Debt 25.44% Exhibit 9 (BV Debt / Market Cap)

re= Cost of Equity 13.2% CAPM (see below)

Levered Beta 1.73 Exhibit 9

Rf = Risk free rate 2.82% Exhibit 10 (10yr Treasury yield)

Market Risk Premium 6% Assumed/Given

Using these inputs, we have calculated the WACC to be 11.92%.

2. What base-case cash flows do you forecast?

 For forecasting base-cash flows, we used the formula:
BCF =EBIT + Depreciation/ Amortization−Taxes

3. What is your estimate of terminal value?

The Terminal Value is the value of the last base cash flow grown at the expected growth rate and
discounted at the WACC less the expected growth rate. This terminal value represents the value of cash
flows just past our forecasts and allows us to forecast farther into the future to make better informed
decisions using given estimates of financial data.
BCF(2014) = 925.24
WACC = 11.92%
g = 10.4%

Terminal Value=BCF (2014)∗g /(WACC −g)

¿ 925.24∗(1.1040)/( .1192−.1040)
¿ 61,028

4. What is the enterprise value of Sun Microsystems?

To calculate the enterprise value of Sun Microsystems, one would add the equity value with the
outstanding debt and minority interest and then subtract off any cash and cash equivalents. Essentially, all
of the information required to calculate the enterprise value can be found from different line items of the
balance sheet in Exhibit 11. The equity value is $5,588.00, which is the value of Total Stockholders’
Equity. The debt value is the amount of Total Liabilities, which is $8,752.00. Lastly, Sun Microsystems
only has cash of $2,272.00. Additionally, it has marketable debt securities, which are liquid assets that are
considered cash equivalents, in the amount of $1,038.00. Therefore, enterprise value is $11,030.00 (see
calculation below).
Enterprise value=equity value+ debt−cash∧cash equivalents=¿
5,588+8,752−3,310=$ 11,03 0
5. What is the equity value?
Equity value can be calculated as the number of shares outstanding multiplied by share price.
However, it is also a subset of the formula to find enterprise value. By simply subtracting off debt and
adding back cash and cash equivalents to the enterprise value, we find the equity value to be $5,588.00,
which is also the Total Stockholders’ Equity on the balance sheet.
D. Conduct a multiples analysis to value Sun. What economic fundamentals are
reflected in the multiples?

Using five companies that are similar to Sun Microsystems and also sell hardware, a multiples
analysis was conducted. Three multiples were found using the averages of these companies. 4.75 is the
multiple for the ratio of EV to EBIT, 2.46 is the multiple for the ratio of EV to EBITDA, and 6.96 is the
multiple for the ratio of EV to Earnings. These multiples reflect how much enterprise value relates to
earnings on many different levels.

E. Identify the synergies and conduct a sensitivity analysis to estimate the effect of
synergies on enterprise value.
Based on the case study, there are several potential synergies identified from the merger
acquisition that could impact Sun Microsystems’ enterprise value. First, the integration charges close to
$1.1 billion of which $750 million was incurred in 2010 and the rest in 2011. Second, the merger will cost
an initial loss of $45 million in operating income because of delayed purchases and loss of customers.
Additionally, due to reconstruction to minimize costs in the merger, Sun Microsystems’ is expecting a
staff reduction of 20% to 25% and SG&A expenses reduction of 22% to 32% (Varney , 2015).
Nevertheless, the “cost-cutting, licensing income, new product, and the integrated application-to-disk
service” will increase operating profit by $900 million yearly; the synergies will take effect gradually over
the next 3 years and reach its full potential in 2013 (Varney , 2015).
To examine the effect of these synergies on Sun Microsystems’ enterprise value, I have conducted
a sensitivity analysis to the best of my capabilities using 2 approaches: stand-alone (without synergies)
and synergies value. Within the 2 approaches calculations, I included the DCF valuation with perpetuity
growth and DCF valuation with multiples. Below I have attached an Excel sheet screenshot
demonstrating my calculations and cited the article I referred to while doing my calculations. Under the
perpetuity method, the growth rate is equal to the risk free rate of 2.82% since we are under the
assumption that the company will grow with the economy ; under the multiples approach, we are using
the EBIT multiples of 4.75 calculated previously. Under the Stand-Alone Approach, the price per share is
$9.00 using the DCF valuation with Perpetuity Growth and $7.86 using the DCF valuation with the
multiple method. Under the Synergy Valuation Approach, the price per share is $16.34 using the DCF
valuation with Perpetuity Growth and $13.13 using the DCF with the multiple methods. In using each
method, different prices per shares were found in relation to the price per share of $6.69 stated in the case
study.

F. If a competing bidder appears, how high a price should Oracle be willing to offer?
 According to Page 1 in the case study, the closing price of Sun on the day Oracle bid was $6.69.
Oracle had a bid of $9.50 per share which is greater than a 40% premium to what Sun had closed with.
IBM, another potential suitor and competing bidder had bid $9.40 per share for Sun. Since Oracle’s bid
was already higher than their competing bidder they should wait to determine if IBM will either increase
their bid or retract it. If IBM remains as a competing bidder, the highest price Oracle should raise their
offer to should be between $13 and $14, which would be double what Sun’s current stock price was.
 Citations
Varney , E. (2015, October 9). Sun Microsystems. Harvard Business Publishing Education. Retrieved
from https://hbsp.harvard.edu/download?url=%2Fcourses%2F896345%2Fitems%2FUV5626-
PDF-ENG%2Fcontent&metadata=e30%3D

Financial Synergy Valuation. Corporate Finance Institute. (2022, February 6). Retrieved from
https://corporatefinanceinstitute.com/resources/templates/excel-modeling/financial-synergy-
valuation/