Two faces of Sun

Sun Microsystems Inc. CEO Scott McNealy was in no mood for apologies. The financial markets were in turmoil, competitors were complaining of slowing sales and the exec was addressing analysts and investors in a mid-January conference call after the company released its second-quarter earnings. Sun, he asserted, would not only weather a deepening market downturn, it would actually prosper.

His evidence looked slim. The US economy was lurching toward a slowdown. Big corporate customers were reining in technology spending, and a worried US Federal Reserve had issued an emergency rate cut only two weeks earlier. McNealy's own CFO, Michael Lehman, had urged analysts moments before to lower their growth projections.

But McNealy was feeling bullish. "I always prefer the tough times," he said. "It's where we weed out the followers from the leaders." Sun, he added, would take market share from its hapless rivals in tough times, just as it has been doing during the good times.

Such bravado is typical of Sun's co-founder and chief of 16 years. McNealy is known as a ready-to-rumble provocateur, unafraid of controversy and unabashed about pushing his view of technology on customers. Despite Sun's faltering stock price, which has fallen 50 percent since August, McNealy wasn't ready to let a little slowdown get in his way.

Its US$15.7 billion in revenue in 2000 notwithstanding, Sun is heading into uncharted territory. Never before as a mature company has it faced a market turnaround as severe as this year's looks to be. If Sun can emerge unscathed, the company will cement its position as one of the most successful technology companies in the world. And McNealy once again will come away looking brilliant.

But if Sun stumbles, its aura of invincibility will dim and McNealy could emerge as a CEO in denial.

Since the mid-1990s, when it produced a virtually crashproof version of its Unix operating system Solaris, Sun has steadily outsold machines from competitors IBM Corp. (IBM) and Hewlett-Packard Co. (HWP) . The company's stock has outpaced even its sales growth, rising 960 percent since 1996.

During the last US recession, in 1990 and 1991, Sun was roughly one-sixth its current size. Back then it focused on selling specialized computers called workstations to engineers and technicians - a cozy business that insulated it from broader economic shifts. Today, Sun's market is worldwide: It supplies the powerful servers that corporations install deep in their networks to host databases, Web sites and business software. Going global has helped fuel Sun's remarkable growth, but it also leaves the company vulnerable to the same economic forces that affect any multinational.

Nevertheless, McNealy's gift for hyperbole is unabated. Despite the dot-com collapse, he claims that "the Internet is still wildly underhyped and underutilized and underimplemented around the world."

That may be. But the slowdown is changing corporate buying habits, as companies become more selective with their investment dollars. "Information technology spending is connected to the health of the economy," says Douglas Tuttle, global director of the high-tech practice at Deloitte Consulting. "This year, CIOs have to be a lot more conservative."

Wall Street analysts now forecast worldwide information-technology spending growth of 7 percent or less this year, down from the 12 percent or so they forecast just months before. A big chunk of this spending goes toward computer hardware - much of it for servers. In other words, Sun's core market suddenly looks wobbly.

Compounding the uncertainty is the financial bloodbath among telecom companies, traditionally among the largest buyers of servers. With many regional upstarts folding their tents, and big long-distance carriers such as AT&T Corp. (T) and WorldCom Inc. (WCOM) slashing spending, server sales will likely fall further.

Sun's competitors, meanwhile, smell blood. IBM and Hewlett-Packard, both of which have revamped their product lines in the past year, hope to take advantage of Sun's delay in bringing to market its new, more powerful servers running the UltraSparc III chip.

McNealy, who declined to be interviewed for this article, argues that slowing spending actually favors Sun: When times are tight, he says, corporations buy more of the servers they already have to avoid the costs, and uncertainty, of switching vendors.

"We feel we can drive through this thing and come out stronger at the other end," says Sun's executive VP John Shoemaker. "We're always going to keep the pedal to the metal."

Nevertheless, Sun executives have found themselves backpedaling from McNealy's comments. His claim that the Internet is underhyped didn't refer to the next 90 days, but to the long term, says one Sun executive. In last month's remarks, adds Shoemaker, "Mike [Lehman] played his role" by cautioning Wall Street, while "Scott played his role" by trumpeting the company's strengths.

To be sure, Sun has been relatively unharmed by the slowdown so far. Quarterly growth sprinted from 27 percent in December 1999 to 60 percent in September 2000, and second-quarter sales rose 44 percent. In a sense, Sun's astonishing numbers in the last two years have raised expectations to unreasonable levels.

But Lehman acknowledged that customer orders dropped in December: "We experienced this change in demand rather suddenly and without much warning," he said.

The lowered projections set off the predictable alarms. "The economic slowdown reduces visibility [into the company's future]," says Merrill Lynch & Co. Inc. (MER) analyst Tom Kraemer, "and raises the risk that Sun could be the next Dell (Computer Corp.)" - which has seen slower growth in each of the last three quarters.

The challenging marketplace also raises the stakes for Sun's newest line of servers, which has been delayed in part by supply problems at chipmaker Texas Instruments Inc. (TXN) . The midrange and high-end machines will not hit the market until later this year - giving competitors a "window of opportunity," says Mark Hudson, worldwide marketing manager at Hewlett-Packard. "It's a very competitive landscape right now. I call it the 'server wars.'"Wars demand generals who are aligned with their lieutenants, and Sun execs maintain that McNealy is right in step. Big decisions at Sun usually emerge from consensus developed at the company's 19-person executive management group meetings, held three to four times a month. The discussions are intense, debate is lively and McNealy is always there.

But even with that intensive preparation, says Shoemaker, "we're not ever sure what Scott's going to say."

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