Business Tech

Update at 9:03 a.m. PST: Comments from Sun added.

Barclays Global Investors has signed aboard as a new shareholder in Sun Microsystems, taking a 3.18 percent stake in the struggling hardware maker, according to a U.S. Securities and Exchange Commission filing Thursday.

Sun, whose stock closed up 10.3 percent on Thursday, at $5.48, after heavy trading volume of 21.6 million shares, has seen its stock on the rise since January 30, when it traded at $4.16 a share.

(Credit: Yahoo Finance)

On the day before Sun's shares started their northward trek, the company's largest shareholder, Southeastern Asset Management, announced in an SEC filing that it was increasing its stake to 22.3 percent from 21.5 percent.

Also on that day, Sun named Rahul Merchant as a new director to its board, as part of an agreement with Southeastern, a large institutional investor.

Southeastern, which in October changed its status from passive investor to activist shareholder, is adding two new directors to Sun's board as part of that agreement. Merchant is the first of the two.

Merchant, a former chief information officer of Fannie Mae and former chief technology officer of Merrill Lynch, has more than 25 years of technology and operational management experience, according to Sun.

Although he comes with an extensive background in tech, executive recruiters say it's unlikely that he was selected to eventually replace Sun CEO Jonathan Schwartz, given that Merchant does not have any prior CEO experience. Rather, they note, he will provide strong technology insight for Sun's product road map.

Sun spokeswoman Karen Kahn noted that she had not heard of any discussions regarding Merchant as a Sun CEO and that the company would not comment on such speculation.

She noted that Southeastern submitted Merchant's name as a potential director and that he was already on Sun's radar, given that he has worked for companies that are Sun's customers. Both Sun and Southeastern are working on finding a second director, but there is no deadline for that to happen, Kahn said.

Last week, Sun reported fiscal second-quarter results that, despite beating Wall Street's expectations, included an 11 percent revenue drop and a loss of $209 million.

The company announced a major restructuring in November, and industry watchers say that may be its only hope, since it's unlikely the company will attract any buyers.

On Friday, longtime MySQL leader Marten Mickos announced that he is leaving Sun. Mickos follows MySQL co-founder Monty Widenius in announcing his resignation from the company.

Southeastern, meanwhile, is looking to use the flexibility it achieved with its changed status as an activist shareholder to hold discussions with Sun's management, as well as third parties, about opportunities to maximize the value of the company for all shareholders. And now Barclays Global is part of that group.

Barclays and Southeastern were not immediately available for comment.

Update at 9:27 a.m. PST, with comments from a shareholder activist research firm.
Correction, 9:35 a.m. PST: This story initially had the incorrect day the agreement was announced. It is Monday.
Update at 1:33 p.m. PST, with closing stock price and excerpt from Southeastern podcast about its board seats.

Sun Microsystems and its largest investor announced an agreement on Monday that entitles the investor to nominate two directors to Sun's board, marking the latest action it has taken to right the struggling company.

Southeastern Asset Management, which holds a 22 percent stake in Sun, will nominate two directors, who will be subject to approval by the board. For Southeastern, this move marks yet another attempt by the company's largest shareholder to improve Sun's performance.

In October, Southeastern announced it not only upped its stake in Sun but also changed its status from a passive investor to an active investor, stating it wanted to maximize shareholder value by holding talks with Sun's management, as well as third parties. Sun's stock has fallen 83 percent from its 52-week high in December last year, while the tech-heavy Nasdaq is down by roughly half that level.

And in its most recently reported quarter, the company posted a $1.68 billion net loss and a 7 percent decline in revenue, while its traditional business of high- to mid-range servers running on Sparc processors took a hit.

In a statement, Jason Dunn, Southeastern's vice president and principal, said:

We fully support Sun's CEO Jonathan Schwartz, and his leadership team in their efforts to continue driving near-term efficiencies and long-term growth.

Sun product lines like Open Storage and Solaris-based Chip Multi-Threading systems along with software infrastructure assets including Java, OpenSolaris, and MySQL, illustrate Sun's enormous growth opportunity. With the appointment of two new directors, the recently announced restructuring, over $3 billion in cash and a long history of cash generation, we are confident Sun is well positioned for long-term success.

Dunn, in his podcast on the agreement, also said, "Southeastern adding two directors to (Sun's) board further strengthens our conviction that Sun will take maximum advantage of all its opportunities for customers and for shareholders.

Southeastern, despite its substantial size of $34 billion in assets under management, tends to wear a velvet glove when prompting change in its portfolio companies. In the last four years, the most aggressive action it has taken against one of its portfolio companies is to withhold its votes to re-elect directors at Telephone and Data Systems--a move that proxy solicitors say is equivalent to issuing a no vote of confidence for the directors in question.

Southeastern's agreement with Sun marks the first time the investment firm has gained board seats as a result of its shareholder activism, according to John Laide, a product manager at FactSet, which tracks shareholder activism.

Neither Southeastern nor Sun was immediately available for comment.

In a statement, regarding the agreement, Sun's CEO Jonathan Schwartz, said:

Southeastern is a knowledgeable partner and investor that has demonstrated great commitment to our long-term vision and success.

Bringing complementary world-class talent to our board community only helps Sun fuel new ideas, drive more innovation and accelerate business opportunities and focus.

According to the agreement, its provisions will terminate in the event of a sale of "substantially all of the company's assets, or a change in control."

Private equity players, however, say the chances of Sun being acquired are zero to none. They note the only best option for Sun is to reorganize and restructure its way out of its problems, a move that the company took last month, its second time for the year

Shares of Sun closed at $3.83, up about 10 percent, Monday.

Sun Microsystems last week launched its second major restructuring for the year--with good reason.

The company posted a sizable $1.68 billion net loss in its fiscal first quarter last month, amid a 7 percent decline in revenue, as its traditional business of high- to midrange servers running on Sparc processors took a hit. Add to that a steep sell-off of its stock over the past 12 months, falling from about $25 a share earlier in the year to close at $3.02 a share on Friday.

For the embattled tech titan that's lost its allure over the years, a dramatic restructuring is virtually the only option to make good for Sun's investors--given prospective buyers aren't around, say some investment bankers and private equity players.

Here are five reasons why Sun won't be acquired, even if its stock is trading at dramatically low prices:

1. Market turmoil and tightening credit markets dish up a double whammy for Sun.

Prospective buyers hoping to use their stock as currency to buy Sun are facing a market that is dramatically undermining the value of that currency. As a result, that leaves prospective buyers with the prospect of using cash--a precious commodity in light of the credit crunch that has enveloped corporate America and beyond.

2. Sun's parts aren't greater than its whole.

The company's software offerings have yet to offset the losses on its traditional business lines, even though it's banking on open source as paving the way to profitability for the company and its high-end Sparc servers. Products from the StorageTek acquisition and legacy storage products are rather long-in-the tooth, said one major private equity player.

And this source noted that any likely buyer that would snap up various parts of Sun (like IBM, Hewlett-Packard, EMC, and Microsoft) is already in the market and taking share. That begs the question of why it would want to buy its competitor's business units when it's already making progress in the market.

Nonetheless, it could still be an attractive proposition. Analyst Toni Sacconaghi of Sanford C. Bernstein said in a research note last week:

We believe a controlling shareholder could also realize meaningful value by selectively selling, harvesting, or growing specific business lines within Sun. We believe such a strategy could drive $7 to $8 per share or more in value, though the value-creation potential is difficult to quantify precisely.

He pointed to Sun's MySQL, Java, and other software assets as potential sale items, as well as letting some of its slow-growth lines of business--such as its high-end Sparc servers, StorageTek, and legacy storage products--die a slow death by scaling back research and development investments, direct sales teams, and support.

Sacconaghi, however, notes such a strategy carries some risks:

The harvest opportunity at Sun carries significant risks for shareholders, however, including uncertainty around what buyers would pay for Sun's assets (and indeed, if any buyers can even be found) and the risk that public equity investors will not ascribe appropriate value to a declining business. Given this, and the relatively limited upside potential available, we continue to believe aggressive cost-cutting is the most viable strategy for Sun to regain profitability.

3. Lack of debt financing makes so-called leveraged buyout companies, which have had turnaround successes with tech companies such as Seagate Technology, a tough go to take the company private.

"There is no debt financing available today, which makes LBOs (leveraged buyouts) a nonstarter in every category, not just tech," Roger McNamee, a managing director with private equity firm Elevation Partners, said in an e-mail interview.

He added it will take both availability of money and a significant easing of rules that regulate LBOs, before there is a sizable increase in the number of technology buyouts. As a result, McNamee does not expect to see any transactions this year involving companies going private.

McNamee added there were a fair number of private equity transactions in tech over the past five years, since the Seagate IPO, but most were transactions where most of the return came from leverage and cost cutting, rather than growth.

"My view is that the better way to do private equity in technology is acquire a large stake and partner with management to transform the company," McNamee noted. "Being public creates hassles during the transformation, but at least you don't have to worry about getting public again."

4. Lack of earnings growth potential and company mismanagement.

A management-led leverage buyout with support from private equity players is not a likely option for Sun, even when the choke hold on debt financing lessens, said another source, who comes from a major private equity firm.

Sun's problems are multifaceted--an inability to deliver a successful strategy, an ineffective management team in CEO Jonathan Schwartz and founder Chairman Scott McNealy, and a lack in its ability to execute, said this private equity source.

As a result, cheap stock or not, it would take demonstrated earnings growth potential to seal a deal.

And one investment banker noted: "They have a great installed base, but their lack of product innovation is hurting them. They need to solve their product position first, otherwise it's like catching a falling knife."

5. There are other investor concerns.

Last May, Southeastern Asset Management, an investor that seeks out downtrodden stocks that show potential, took a 10 percent stake in the company and steadily increased its position through the fall to 21.2 percent.

But late last month, it became apparent this investor was not a happy camper. In a filing with the Securities and Exchange Commission, Southeastern Asset Management went from being a passive investor to an active one, in which it wants the flexibility to hold talks with Sun's management and also third parties.

Southeastern has previously declined to comment on its investments in Sun.

And KKR Private Equity Investors, which last year , will likely want its principle paid back in cash and not Sun stock, when the notes come due in 2012 and 2014.

Sun's shares are currently trading substantially below the $7.21 a share value that would be assigned to its stock if KKR wanted its $700 million principle in Sun shares and not cash.

KKR declined to comment on its Sun investment, but one private equity investor noted Sun's shares are underwater in relation to the $7.21 a share price. So it makes more sense for KKR to take the money, rather than to become a sizable equity holder in the company.

Sun was not immediately available for comment.

Sun also may be less attractive to private equity players because its $2.6 billion in cash and short-term securities is not as sizable as it may seem. When adding in the $700 million in senior debt that Sun will likely have to pay out in cash, that reduces its net cash and short-term securities by roughly a third.

As a result of these factors, a white knight buyer is unlikely to appear on the horizon anytime soon, despite Sun's cheap stock price, which is down 85 percent from its 52-week high, and substantially lower value in comparison to its competitors IBM, HP, and Microsoft.

It's a "screaming deal," said the investment banker. That is, if you don't look at all those other factors.

The investment firm gobbling up shares of Sun Microsystems might look tough, but it usually avoids playing hardball with executives.

Sun got a wake-up call last week from its largest single investor, Southeastern Asset Management, which added the hardware maker to its list of companies for which it has switched from being a passive investor to an active one, with regard to corporate governance, operations management, and increasing shareholder value. But while the road ahead may be bumpy with this activist shareholder, which had $34 billion in assets under management as of the end of September, it will likely be far from bruising, if history is a guide.

While Southeastern, a self-described value investor seeking to make investments in companies whose stock price is trading less than the company's intrinsic value, hasn't been shy in turning up the heat on its portfolio companies, it has yet to go public with caustic letters to management or launch a hostile proxy fight, according to data from FactSet SharkWatch.

"Southeastern's tactics have been less severe than other shareholder activists'," said John Laide, a product manager at FactSet. "The most aggressive action they've taken in the last four years is a withhold vote."

Although withholding a vote generally does not prevent a director from being re-elected, it is meant to nonetheless send a clear message to a company about the level of investors' dissatisfaction.

In its U.S. Securities and Exchange Commission filing over its change in status as a Sun investor, the investment firm had noted that it intends to talk to Sun's management and third parties:

As the result of investment analysis or the occurrence of events, Southeastern may desire to participate in discussions with the particular portfolio company's management or with third parties about significant matters in which Southeastern may suggest possible courses of action to assist in building corporate intrinsic value per share or to cause the company's true economic value to be recognized...In this situation, Southeastern has talked to (Sun's) management and will have additional conversations with management and/or third parties, regarding opportunities to maximize the value of the company for all shareholders.

It remains to be seen whether Southeastern will ramp up its activist activities with Sun. The Silicon Valley mainstay declined to comment on Southeastern, following the activist shareholder's SEC disclosure, other than to note that it has spoken with Southeastern in the past, as it does with all shareholders. Southeastern also declined to comment, after its SEC filing, noting that it does not discuss its portfolio companies.

In the past four years, Southeastern has gone from passive to active on six companies, four in which (including Sun) it saw an opportunity to maximize shareholder value.

For Telephone and Data Systems, Southeastern expressed concern about the way its board of directors were governing the telecommunications company by withholding a vote to re-elect four of its independent directors, according to FactSet SharkWatch.

A majority of activist investors tend to follow a similar model to Southeastern's, not escalating their actions beyond engaging with a company's management, FactSet's Laide noted, in contrast to the high-profile manner in which Carl Icahn has waged battle, from his proxy fight against Yahoo to his successful role in pushing BEA Systems to accept an unsolicited bid from Oracle.

According to Southeastern's SEC filing regarding TDS, it believed that the company had withheld information about an all-cash, "full and fair" bid for the telecommunications company.

In the filing, Southeastern noted:

After learning of the bid's rejection without public disclosure, Southeastern wrote to the full board, demanding an explanation.

The board wrote back and refused to comment on the bid but stated that it would "serve no valid business purpose for a board of directors to attempt to take action that cannot succeed due to the controlling shareholder's lack of support."...Southeastern does not believe that the independent directors have been proactive enough in seeking to persuade the Carlsons of the merits of the proposed transaction.

The Carlson family holds a 51.8 percent stake in the company. And despite its stated views in the SEC filing, Southeastern never launched a publicity campaign around the issue.

TDS, meanwhile, has found its relationship with Southeastern, one of its largest single shareholders, a workable relationship.

"They're not at you every day. In fact, sometimes, I feel the need to call them to make sure they got our latest (quarterly) numbers," said Mark Steinkrauss, vice president of corporate relations. He added that Southeastern makes its views known and said some of its suggestions, such as a stock buyback plan, will be pursued.

And if TDS does not act on Southeastern's recommendations?

Said Steinkrauss: "They've always acted courteous and professional."

Sun Microsystems' largest shareholder, Southeastern Asset Management, has upped its stake and taken a more aggressive attitude toward its investment, indicating that it will take an active role in maximizing shareholder value through talks with management and third parties, according to a filing with the U.S. Securities and Exchange Commission on Wednesday.

Southeastern, an investment advisory service and self-described value investor in large-cap, mid-cap, and small-cap companies, increased its stake to 21.2 percent from its previous investment in September of 17.3 percent.

In noting the increased stake and change in its status as a passive investor to one that wants the flexibility to take a more active role, Southeastern stated in its filing:

In this situation, Southeastern has talked to the issuer's management, and will have additional conversations with management and/or third parties, regarding opportunities to maximize the value of the company for all shareholders.

To obtain the flexibility to discuss various alternatives, including any of the actions or transactions enumerated in clauses A through J of Item 4 of Schedule 13D, with the Issuer's management or with third parties, Southeastern is converting its ownership filing on Schedule 13G to a filing on Schedule 13D.

Converting to a passive investment stake, as indicated in Schedule 13G, to a Schedule 13D allows Southeastern to take an active role in which it can work with other investors. Southeastern obviously isn't a happy camper, especially after Sun's stock took a dramatic 17.5 percent plunge on an earnings warning Tuesday to close at $4.77 a share.

Sun's stock is trading below $5 a share for its second consecutive day. And in certain cases, institutional investors, such as pension funds and asset managers, are prohibited from owning stock in companies that trade for less than $5 a share.

"We have talked to (Southeastern) and will consider their input, just like we consider the input from all our investors," said Dana Lengkeek, a Sun spokeswoman. She declined to comment on the content of those discussions with Southeastern, as well as with other institutional investors. She added Sun speaks to its investors on a regular basis.

According to SEC filings, Southeastern initially took a 10 percent investment stake in Sun Microsystems back in late May. That's when the stock was trading around $13 a share.

Since then, Southeastern has steadily ramped up its investment as Sun's shares have continued to fall. In August, Southeastern noted in an SEC filing it had increased its stake to 16.5 percent and in Sun's proxy statement last month, it was listed as a 17.5 percent stakeholder.

A spokeswoman for Southeastern Asset declined to comment on the company's increased stake and desire to play an active role in maximizing shareholder value at Sun, noting that the company does not comment on companies in which it has holdings.

But in a BusinessWeek story published earlier this month, a Southeastern Asset manager had this to say about Sun Microsystems:

Sun's largest shareholder is also optimistic. Southeastern Asset Management boosted its stake to 17 percent of the shares outstanding, because of Sun's rising cash flow and promising new product. "This is such a deeply misunderstood story," says Jason E. Dunn, one of the firm's managers.

This post was updated at 1:50 p.m. PDT with comment from Sun.

This post was updated at 2:27 p.m. PDT with information on Southeastern's history of acquiring Sun shares.

This post was updated at 3:53 p.m. PDT with a comment from Southeastern Asset.