Sun microsystems case study valuation

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Approved Logo 1 Sept 2013

BNFN 4304 – Financial Policy

Mr. Masood Aijazi

Case 48: Sun Microsystems

Spring Semester 2017 – 2018

Authored By

Maryam Barifah 1420023

Nour Abdulaziz 1420149

   Yara El-Feki 1410435

                                            Balquis Mekhlafi 1410231

Shrouk Al-Jaaidi 1420072

Submission Date

10/05/2018

Guidance Sheet

Synopsis

This case calls for students to reevaluate the price Oracle should pay to acquire its long-term business partner, Sun Microsystems. The emergence of new suitors (e.g., IBM) forces Oracle’s corporate development team to go back to the drawing board and reevaluate all the assumptions they have made in putting together the initial bid of $7.38 million, or $9.50 per share, on April 17, 2009. Students are invited to value Sun’s stock and take a position on whether there is any room left to sweeten the offer if a bidding war unfolds. The case outlines the Oracle strategy and how long-term partnering with Sun contributed to it to date. It also allows for an in-depth discussion of the changing competitive landscape of the technology industry.

The case is an exercise in valuing a potential acquisition target. It presents an opportunity for students to develop appreciation for valuing a company using both discounted cash flow and multiples in their analysis. Particular attention should be paid to the inclusion of synergies and their relevance to the valuation. The bidding dimensions of the case are highlighted by the presence of other potential acquirers.

Objectives

The primary objectives of this exercise are to introduce or reinforce valuation tools in the context of mergers and acquisitions:

1. Analyzing a variety of strategic, organizational, financial, and economic issues associated with mergers and acquisitions

2. Developing a framework for valuing acquisition candidates

3. Evaluating both quantitative and qualitative factors affecting merger agreements

The case could benefit from being assigned together with the technical note “Methods of Valuation for Mergers and Acquisitions” (UVA-F-1274).

Executive Summary

Oracle one of the world’s biggest and most legitimate vendors of database management system and other related programming is having to deal with an acquisition decision. Oracle is thinking to acquire Sun Microsystems, which is mainly in the industry of making hardware equipment, storage and offering different services at enterprise level. Per the case study, the combination of these two companies could make the Wal-Mart of the enterprise programming industry. In addition to this, the intention of this report is to evaluate whether Sun Microsystems would be a good fit for Oracle and what price should be offered for it. For Sun Microsystems, we used both valuations which are the Base-Case (Stand Alone) and the expected synergies after acquisition. We found a way to utilize three diverse ways to deal with the value of Sun Microsystem. First approach was to include the market capitalization and the debt of Sun Microsystem to decide an enterprise value of about $6.20 billion. Second, utilizing a multiple analysis based on comparable companies to determine the enterprise value which is about $3.87 billion. The third is utilizing the discounted cash flow method, we decided that Sun Microsystem’s enterprise value to be about $4.53 billion as a stand-alone company that is about $8.95 billion. The uniqueness between the values from the different methods that were being used was because of the various assumptions.

Table of Contents Executive Summary 3 Introduction 5 1. Is Sun Microsystems a good strategic fit for Oracle? Should Oracle acquire Sun Microsystems? 5 2. How much is Sun worth? What approaches would you use to place a value on Sun Microsystems? (Hint: Stand-Alone Value, Acquisition Price and Value with Synergies) 7 The Stand Alone and Value with Synergies methods for valuation using the WACC was calculated as follows: 8 Steps for WACC calculation are seen in the excel sheet: 9 3. Assuming a discounted cash flow valuation: 9 a. What rate of return should Oracle require on the acquisition? 10 b. What base-case cash flows do you forecast? 10 c. What is your estimate of terminal value? 11 d. What is the enterprise value of Sun Microsystems? What is the equity value? 12 4.Conduct a compare companies or multiples analysis to value Sun. What economic fundamentals are reflected in the multiples? 12 Multiples of Comparable Companies 13 Multiples Analysis 15 Economic Fundamentals 16 5. Identify the synergies and conduct a sensitivity analysis to estimate the effect of synergies on enterprise value. 16 The below table shows the sensitivity analysis for the two approaches: 20 Stand-Alone Sensitivity Analysis: 20 Synergy Value Sensitivity Analysis: 21 Summary of Results: 21 6. If a competing bidder appears, how high a price should Oracle be willing to offer? 22 Conclusion 23

Introduction

The computer industry is an extremely competitive and the organizations are always searching for new way to evolve to be a step ahead of the competition at all times. In 2009, Oracle was planning to acquire Sun Microsystems. This acquisition would allow Oracle to further diversify their brand, customers and acquire various new platforms that would be added to their portfolio such as MySQL, Solaris and Java. Oracle originally placed an offer of $9.50 per share price which is considerably higher than Sun Microsystem’s price that is $6.69. In addition to this, Oracle levered the company’s value with the acquisition of Sun Microsystems through complementing their system with hardware manufacturing. This will cut the production costs and make the company more efficient throughout all the value chain. The acquisition will pool Oracle’s leading position in the software area with Sun Microsystem’s proficiency in hardware and networking. Moreover, Oracle aimed to capitalize on Sun Microsystem’s decline by getting particular assets or the whole company at the deflated price. The main issue that Oracle needed to confront was to make an accurate valuation model to think of a reasonable price for Sun Microsystems share price. Additionally, Oracle had to ensure that acquiring Sun Microsystem would convey benefits and productivity to its operation.

1. Is Sun Microsystems a good strategic fit for Oracle? Should Oracle acquire Sun Microsystems?

The financial position of oracle in 2009 was much healthier than that of Sun Microsystems, as in that year Sun was steadily losing its market share in the hardware business market, therefore to increase their revenues they tried to leverage software systems by making the Java Solaris, and acquiring MySQL. Unfortunately, this did not sustain Sun performance for a long term especially with the 2007 crisis that affected their financial performance negatively. As a result they found that the most suitable action they could undertake is under an acquisition position. This acquisition will benefit Oracle in many aspects and will aid Oracle in becoming the enterprise software industry's Wal-Mart.

Although both businesses are considered of similar industry, yet they sell different product as Oracle primarily manufacture business software while Sun professionalize in hardware and networking. Consequently, Oracle could add Sun Microsystems to its firm as a vertical integration acquisition and benefit from the diversification of products that would occur when adding the strength of Sun's to Oracle's thus creating a preferred business offering. There were two main technology system software used by Oracle in 1997 that are Java programming language and Solaris (an open-source platform), and these two were owned by Sun Microsystem. Oracle and MySQL database management systems both targeted different customers therefore they were not having a direct competition, thus the addition of MySQL will add to Oracle's portfolio and may well be able to attract and sell their software to high-end clients. Moreover, Oracle could add Sun Microsystems solid position in the software industry to its Java MySQL, and Solaris systems toward its portfolio.

The beginning of the technology industry started with three main sectors software, hardware and services storage and peripherals, but with the industry developing in the new millennium, there began uncertain lines of segments. Considering Apple's store, where customers could purchase their needed software, hardware and peripherals from just one store have made other technological businesses to reconsider their strategies in business development.

Sun Microsystem is considered a good fit for Oracle for several reasons, primary is to achieve their vision of becoming the Apple in the technological sector for businesses, by providing both hardware and software components, as stated by Oracle's CEO Larry Ellison. Moreover, Ellison could achieve the vision by this acquisition and will also allow Oracle to distribute high-quality products from the combination of hardware and software components and therefore reducing customer set-up procedure.

Lastly, the addition of Sun Microsystem will allow Oracle to expand. The acquisition perfectly fits Oracle's strategy that justifies improving through acquisition and effective integration with other companies. Moreover, Oracle has spent more than 30 billion on acquisitions since 2005, thus Oracle is familiar with similar situations as this allows them to study the intended company and perceive possible synergies. Therefore, due to all the listed benefits Sun Microsystem is considered an immense proposal.

2. How much is Sun worth? What approaches would you use to place a value on Sun Microsystems? (Hint: Stand-Alone Value, Acquisition Price and Value with Synergies)

Firstly, to know how much the Sun Microsystem is and how to value it, we must find the Stand Alone Value of the company. The Stand Alone value represents the present value of Sun Microsystem individually before factoring the synergy that would be created when Oracle acquires Sun. It is the excess amount of money that the shareholders of Sun Microsystem receive. It is a mean to value the firm before any merger or acquisition occur, and it useful to see whether or not the target company is undervalued or overvalued by comparing it with current share prices.

Secondly, the value of Sun Microsystem with synergies, which after being acquired by Oracle, must be found. This is done to see whether or not the acquisition was a proper strategic decision or not; keeping in mind that the value of synergies was considered to be the added amount of money that has been received by Oracle’s shareholders. If the acquisition proves to be a fit strategic decision then the value of the company included within this deal will grow significantly; this is known as the synergy effect. The cost saving and the extra gain in revenue and efficiency that is achieved when two companies merge is represented through Synergies, as show in the attached excel sheet in Q.3.2, Q.3.3, Q.5.2, and Q.5.3 and as explained in Question 5. Another method of valuating the Sun Microsystem is through the comparative company analysis (CCA), aka. Trading comps. That is done through the thorough assessment of rival and peer businesses of similar size and industry.

Finally, the acquisition price, which is the price that is paid to the target when it is first acquired, is also used as a separate method of valuation. The value of the acquisition price ranges between the values of the stand-alone and the synergies.

To be able to find the values of both, the Stand Alone and the synergies, we have decided the best way to do so is by calculating the discounted cash flow (DCF) by using the multiples and the perpetuity growth methods and finding the average of both.

However, there are a few challenges that we potentially could face using both of these methods and they are as following: