Oracle's strange Java brew

NEW YORK (CNNMoney.com) -- If the term "serial acquirer" were actually in the dictionary, it would probably be accompanied by a picture of Oracle Chief Executive Officer Larry Ellison.

Oracle (ORCL, Fortune 500) announced Monday that it was going to buy struggling server and software firm Sun Microsystems (JAVA, Fortune 500) for $9.50 a share, a 42% premium to Friday's closing price for Sun. The deal, including Sun's cash and debt, is valued at $7.4 billion.

Assuming the deal closes without any hitches, the Sun purchase will be Oracle's 52nd acquisition since January 2005. The software giant completed its takeover of rival PeopleSoft that month following a year-and-half long battle for the company.

Most of the deals since then have been relatively small and friendly, but there have been several multi-billion purchases sprinkled in, including the acquisitions of Siebel Systems, Hyperion Software and BEA Systems. BEA, like PeopleSoft, initially resisted Oracle's unsolicited offer.

Still, Ellison's bold move for Sun, which had earlier been in talks to sell to IBM, may represent Oracle's biggest gamble yet. IBM offered to buy Sun for $9.40 a share, but those discussions collapsed after Sun balked at IBM's price.

In some respects, the deal for Sun represents a way for Oracle to become an even bigger threat to IBM (IBM, Fortune 500), not to mention the likes of Hewlett-Packard (HPQ, Fortune 500) and Dell (DELL, Fortune 500), since it too will now be able to offer a one-stop shop of hardware and software to big corporate customers.

But it's worth wondering if the Oracle deal is more about Ellison's ego and sheer bigness for bigness' sake and less about good common business sense.

In a research note put out Monday morning, Technology Business Research analyst Stuart Williams pointed out that the addition of Sun will allow Oracle to easily eclipse Ellison's 2005 goal of getting Oracle's revenues over $30 billion by 2009. Williams estimates that the purchase of Sun would vault Oracle over the $40 billion annual sales mark.

However, Williams added that Ellison's other goal for 2009 -- that of 40% operating margins -- will now take longer to achieve because of the addition of Sun's low-margin hardware business.

To be sure, Sun has some interesting software, namely its ubiquitous Java programming software language and its open source MySQL database software and Solaris operating system.

But software remains a tiny fraction of the business -- despite the company's changing of its ticker symbol from SUNW to JAVA in 2007 to tout its software prowess.

When the company reported its fiscal second-quarter results in January, Sun said that "total software" sales rose 21% from a year ago, which is impressive. But the annual run rate for the division was just $600 million.

To put that in perspective, analysts expect Sun to report total sales of $12.4 billion this year. Sun remains predominantly a hardware company stuck in a brutally competitive business. And that's why analysts expect the company to post a loss in this fiscal year.

TBR's Williams does think that the deal makes sense for Oracle, though. He argues that Oracle now will be able to package its database and middleware software with Sun's servers, storage technology and Solaris operating system. That could help Oracle win some deals at the expense of Dell and storage company EMC, Williams wrote.

Larry Coats, co-manager of the Oak Value fund, which owns shares of Oracle, said that the Sun deal has the potential to add $1.5 billion to $2 billion in operating earnings over the next two years. He added that Sun's problems may stem more from bad management decisions than any significant problem with the business.

Interestingly, Wall Street didn't seem too upset with the deal either. Shares of Oracle were down about 2% in late morning trading Monday, a fairly mild sell-off for a company announcing a big purchase.

Ron Muhlenkamp, manager of the Muhlenkamp fund, said he thinks the deal looks like a good fit. Muhlenkamp, who owns shares of Oracle in his fund, said that he's not overly concerned about risks tied to the deal.

"Historically, Oracle has done a decent job of integrating acquisitions when buying companies. And they are doing this deal with cash," he said. When companies issue new shares to fund acquisitions, that often dilutes the value of existing shareholders.

Ted Parrish, co-manager of the Henssler Equity fund, which also owns shares of Oracle, agreed that the Sun deal should help Oracle, particularly because of the addition of Java.

And to be fair, Oracle has pulled off nearly all of its previous deals of the past four years with considerable aplomb. The knock on Oracle before it started buying just about every application software company in sight was that it was a stodgy database software firm that would never be able to compete with the likes of SAP (SAP) and Microsoft (MSFT, Fortune 500).

But as the chart above and to the right shows, Ellison's had the last laugh. Oracle's stock has vastly outperformed shares of SAP and Microsoft since the start of 2005.

Still, there are many examples of companies that eventually ran into trouble because of excessive deal-making. At some point, Ellison may be biting off more than even he can chew.

"We had thought the acquisition binge was just about done. We didn't see this coming," Parrish said. "When is enough enough? I'm a little concerned about the rapid pace of deals and that sooner or later they could buy something that may not work out so well."

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