Sun's $2B Cobalt Acquisition Brings It To Entry-Level Hosting, ASP Market

Sun Microsystems' $2 billion acquisition of Cobalt Networks will help expand Sun's Internet presence into the low-end Web-hosting and ASP market, company executives said this week.

The company entered into an agreement to purchase Cobalt, a leading vendor of server appliances, executives said. Sun will convert one share of Cobalt stock into 0.5 shares of Sun stock, valuing the deal at about $2 billion.

Executives at both companies said they see the deal as a win-win situation for all involves, as well as for Sun channel partners.

"We had been looking at the server appliance market and had done some things, but this gets us to market in one fell swoop," says John McFarlane, executive vice president at Sun. "It helps get us in the low-end, volume growth area and extend our server market."

The acquisition makes Cobalt big real fast, says Stephen DeWitt, president and CEO of Cobalt. The appliance market requires full channel and system resources, he says. "At the end of the day, you are either No. 1 or No. 2 or nothing else. . . . The key is getting big fast. This lets us scale quickly."

The acquisition also puts Sun in markets unfamiliar to the IT giant. Cobalt uses Intel-compatible processors and the Linux operating system in many of its products. In March, Cobalt acquired ChiliSoft, a developer of software solutions for Active Server Pages, a Microsoft-led standard for interactive Web applications.

The timing of the acquisition seems right, says Pushan Rinnen, senior analyst at Dataquest. The research firm expects the server appliance market to reach 2.8 million units by 2004, about 21 times the sales of 133,000 units last year. Server appliance revenue should reach about $14 billion in 2004, compared to only $1 billion in 1999.

Among traditional server vendors, Sun has the smallest portfolio in the server appliance market, Rinnen says. Dell, IBM, Hewlett-Packard and Compaq have all entered the entry-level appliance market in a big way. "Sun can't ignore this trend, especially in the Web-hosting and ASP market," she says.

About 14 percent of the server appliances sold last year were shipped from Cobalt, including the RaQ appliances for Web-hosting data centers and the low-end Qube appliances for installation at customer sites, Rinnen says. "Sun does not have such kinds of solutions," she says. "It can use Cobalt to target Web hosts and ASPs and can say to them now you can plug this into your racks."

In addition to the products, Sun also gets a big team of Cobalt application developers, while Sun will provide Cobalt a much larger worldwide distribution base, Rinnen says.

While growth in the server appliance market is expected to boom, education of the customer base still remains one of the greatest hurdles, Rinnen says. IBM, which last year purchased Whistle, has yet to see sizable revenue from its WebConnect service, she says. However, Sun's acquisition of Cobalt is expected to be smoother because the market momentum for server appliances seems better than last year, she says.

Cobalt currently has OEM relationships with several ASPs and is working with Seagate to develop server appliance technology as a result of an agreement the two signed in April. The OEM business is expected to continue and even expand after Sun's acquisition, DeWitt says.

The acquisition is expected to be good for both companies' indirect channel efforts, McFarlane and DeWitt say.

Cobalt has both direct and indirect sales forces, McFarlane says. "[Sun] can put a super charger behind the sales channels by giving them access to both cobalt and Sun channel partners," he says. "[Cobalt] gets the keys to the cookie jar."

McFarlane expects twofold channel opportunities from the deal. "[Cobalt's] teams have partners that give us access to their market," he says. "And Sun's service provider market has been growing faster than Sun as a whole, giving [Cobalt's] people access to a big service provider base."

How well the Cobalt products do under the Sun banner depends on how Sun handles the services side, says Jim Quasius, vice president of operations at Gateway Computer Associates, a St. Petersburg, Fla.-based Sun solutions provider.

Quasius says since most of the company's business is in the high-end, he is ambivalent about the deal. "We don't spend a lot of time in the low end," he says. "Sun is driving us to sell more services. If Sun can add more services [to the Cobalt product], I might be interested."

From a solution provider perspective, Sun has been unequivocal about driving its partners to make services a core part of their business, Quasius says. "And it's been good for us," he says. "Services are now over 50 percent of our business, and we're an old-time VAR."

Investors seem to like the deal, which was announced before the start of the trading day. Shares of Sun rose 2.1 percent to $117.69, while Cobalt shares ended the day at $57.19, a rise of $16.06, or about 39 percent.