Sun Debt Rating Downgraded to Junk-Bond Level

Debt-rating agency Standard & Poor’s (S&P) has downgraded Sun Microsystems’ debt to junk-bond levels, citing the threat of increasing competition and Sun’s inability to remain consistently profitable.

In a report, S&P said it lowered Sun’s bond rating one grade to BB+, though it noted that Sun has a stable outlook with enough cash on hand to handle its outstanding debt.

“The downgrade reflects weak and inconsistent profitability, and our expectation that Sun will be challenged to profitably expand its market presence,” S&P analyst Martha Toll-Reed said.

Narrow Base

The credit agency said Sun has a “relatively narrow revenue base” compared with competitors IBM and Hewlett-Packard, and has not been able to consistently report profitable quarters in the past two to three years.

Additionally, S&P “does not expect profitability to return to historical levels in the near-to-intermediate term, given fierce industry price competition and Sun’s high R&D investment rate.”

Sun could not be immediately reached for comment. In a statement issued in the wake of the downgrade, the company cited its strong cash reserves of more than US$5 billion, an amount that far outstrips its $1.3 billion in bond-related debt.

“With this strong financial foundation, a broad range of products, technologies and solutions, and a global base of customers and partners, Sun is well positioned to achieve its goals,” the statement said.

Making Strides

IDC vice president Jean Bozman noted that Sun has been fighting aggressively to gain market share, especially in recent months. The company has gained traction with its AMD Opteron-based server line, which pushed competitor HP to announce plans to bring a similar product line to market.

Sun also has targeted HP users with an expanded version of its HP-Away program, an effort to lure customers who may be tired of waiting for HP to release long-awaited new server products.

Still, Sun faces the prospect of fighting off competitors that have more momentum. Bozman noted that Dell in particular has been gaining market share in the small-enterprise space and seems poised to turn those gains into customer wins among larger corporations as well.

“The server space became viciously competitive during the downturn, with every company forced to steal market share to see any growth at all,” Bozman told the E-Commerce Times. Now, she added, “even with the overall market growing, you’re still seeing head-to-head battles in every corner of the market.”

Sun also has tried to revamp the way it sells its software in an attempt to simplify IT managers’ purchasing decisions. “Those moves are aimed more at preserving their existing customer base,” Bozman noted.

Chilling Effect?

However, Gartner analyst Daryl Plummer said the bond rating could have a chilling effect on some Sun customers, who have expressed concern in the past about the company’s relatively low stock price.

Although Sun is financially solid enough that bankruptcy is not a concern, it has been rumored as a likely takeover target because of its relatively low per-share price. That uncertainty might help tip a customer to another company that appears more solid from a distance.

“A lot of enterprises were burned by folding companies in the past,” Plummer told the E-Commerce Times. “Before a company invests in a system that’s at the core of its entire IT infrastructure, it’s going to want to feel very comfortable.”

Money Matters

Ironically, Sun’s high R&D investment was one of the factors cited by S&P in the downgrade. Sun spends about 16 percent of its overall revenue on R&D each year, substantially more than the industry standard. The company has long touted that outlay as evidence it will remain on the cutting edge of enterprise information technology.

While the downgrade deals a blow to Sun’s overall image, it may not have a dramatic practical impact on the company unless Sun needs to raise cash quickly for an acquisition or other capital-intensive move, analysts said. Still, shares of Sun stock were trading lower Monday morning at $4.64, down about 3 percent.