September 19, 2000 2:20 PM PDT

Sun scoops up Cobalt for $2 billion in stock

Sun Microsystems today said it will purchase Cobalt Networks in a $2 billion stock transaction, a move that Sun says will accelerate its entry into the server appliance market.

The deal marks a major strategic shift for Sun, whose bread and butter has been selling general-purpose servers. While general-purpose servers still are very important for high-end corporate computer networks, special-purpose "server appliances" such as those Cobalt sells typically are less expensive, easier to use, and geared to a specific task.

The deal also means that Sun, at least for the time being, will be incorporating two foreign technologies into its product line: Intel-compatible Advanced Micro Devices CPUs and the Linux operating system.

Sun, like AMD, is duking it out with No. 1 chipmaker Intel to win as large a presence as possible in the future computing market.

"We like AMD. The enemy of our enemy is our friend," Jonathan Schwartz, Sun's senior vice president of corporate strategy and planning, said in an interview today.

However, in the long term, Sun expects to move Cobalt's products over to Sun's UltraSparc CPUs and its Solaris operating system, Schwartz said.

Cobalt's shares shot up on the news. At the close of regular trading, the stock was up $16.06, or 39 percent, to $57.19 on a volume of 11.9 million shares--18 times its average daily volume.

"In general, it looks like it's a good move. This is a weak area for Sun--server appliances at the low end of the spectrum," Dataquest analyst Jeff Hewitt said.

Merrill Lynch analyst Steve Milunovich agreed. "We think it makes sense for Sun to enter the server appliance market," he said.

Under the terms of the agreement, each share of Cobalt common stock will be converted into half a share of Sun stock, resulting in an aggregate purchase price of approximately $2 billion. The acquisition should be completed by Dec. 31.

Sun has avoided the server appliance area, but its Intel-based competitors such as Dell Computer, Compaq Computer, IBM and Hewlett-Packard have been moving to embrace the special-purpose servers.

"This sets the stage for a bigger battle between Sun and all the leading Intel server vendors," Gartner analyst John Enck said.

Indeed, it sets the battle directly with Intel as well, which has its own server appliance line called NetStructure.

Even though server appliance sales cut into revenues from more expensive general-purpose models, analysts say these large companies must adopt server appliances or face losing the business altogether to start-ups.

Sun has been lukewarm on the rise of Linux, which is similar to but less mature than its own Solaris version of Unix.

While sales of Linux computers, usually based on Intel chips, have cut into low-end Sun server sales, Sun argues that Linux's cultural and technological similarity to Solaris means it's an easy upgrade to Solaris. Linux's growth has been cutting into the market share of both Solaris and Windows, market researcher International Data Corp. has said.

IDC has estimated the server appliance market will hit $12 billion by 2004.

Cobalt makes a server appliance called the Qube based on a CPU from MIPS that offers small businesses an easy way to connect to the Internet, but the company has been focusing more attention on its rack-mounted Raq products, which handle tasks such as housing Web pages or storing Web site information in "caches" closer to the person who needs it. Cobalt unveiled its newest product, the AMD K6-2-based Raq4, in July.

The company also sells a product for adding storage capacity to local networks.

"We're acquiring Cobalt to establish ourselves in low-end server appliances and immediately jump into the marketplace with a proven, world-class product offering," Sun president Ed Zander said in a statement.

Of all of Cobalt's products, Schwartz said, Sun in most interested in the Raq computers for hosting Web sites.

Schwartz said Sun is also pleased that it will own Cobalt's ChiliSoft software, which lets Sun and Linux computers use a Microsoft technology called Active Server Pages (ASP) that creates customized Web pages.

Sun has a competing technology called Java Server Pages. JSP is a "superior technology," Schwartz said, but Sun recognizes that "there are a lot of people who use ASP."

Palo Alto, Calif.-based Sun makes computer servers but has relied on resellers and software companies to specialize its products. "Now with this deal it will offer a more complete product on its own," said Shebly Seyrafi, an enterprise hardware analyst at A.G. Edwards.

Analysts say the move symbolizes Sun's seriousness about moving into the server appliance market and taking on its competitors.

"It's not simply willing to sit by and let other companies take over that market," Seyrafi said. "In terms of jump-starting its already good presence in the appliance area, this is a solid acquisition."

 

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