April 2, 2004

Analysis: Sun, Microsoft interop deal a smokescreen?

Author: Chris Preimesberger

SAN FRANCISCO -- It took seven years, millions upon millions of shareholders' dollars, and way too many snide remarks from both sides, but Sun Microsystems and Microsoft have now stopped their Hatfields vs. McCoys legal feud and are apparently ready to compete more civilly in the marketplace. (Go here to read Melanie Hollands' stock analysis on ITMJ.)

Deep into the April Fool's Day night and into the wee hours of the morning Friday, former Stanford Business School classmates Scott McNealy and Steve Ballmer finally looked each other in the eye and came to a general agreement that they say will eventually put to rest the longstanding antitrust ligitation, the FUD-slinging, and much of the near-slanderous rhetoric that has permeated their corporate relationship for years.

As a result of the 10-year agreement, Microsoft will pay Sun $1.6 billion -- $900 million to resolve patent issues and $700 million to end pending antitrust problems -- in settlement and will maintain and update its support of the Java Virtual Machine in its desktops and servers. In addition, Sun and Microsoft have agreed to pay royalities for the use of each other's intellectual property, mostly involving Windows Server, Windows Client, the Sun Java System Identity Server, and JVMs. Microsoft will make an up-front payment of $350 million when the JVMs are updated in the next Windows XP patch. Sun will begin making royalty payments to Microsoft when it starts upgrading Windows-interoperable networking components in its Solaris server boxes.

For its part, Sun has agreed to license the Windows desktop system communication protocols -- which is interesting in light of all the time and money Sun has invested in the Java Desktop System -- and said it will work closely with Microsoft to improve the interoperability of the Java and .NET platforms. Cross-licensing agreements will be involved, and a Windows certification for Sun's new Xeon-based servers was also announced.

Importantly, nowhere in the 10-year agreement (see press release) does it specify that the companies may not sue each other in future disputes involving IP or anything else, although it does say that "the agreement also provides for potential future extensions of this type of covenant."

Sun also said that the agreement satisfies its objectives in its support of a European Union lawsuit against Microsoft, in which the EU ruled that Microsoft must change the way it bundles feature software (such as Windows Media Player) in its operating system, calling it an anti-competitive business practice.

A crucial moment for Sun

On the other hand, the announcement of the big handshake comes at a crucial moment for Sun, which announced its quarterly financial results at the exact same time. And they're not good.

The Santa Clara, Calif.-based corporation is estimating a net loss of between $750 million and $810 million -- prior to some restructuring and tax asset charges -- on revenue of $2.65 billion, a far bigger loss than Wall Street had been told to expect. The final loss in the quarter ending March 28 will be in the $200 million to $260 million range. Sun has now announced losses in 11 of the last 12 quarters.

Sun also said it would close two major manufacturing operations in the UK and lay off 3,300 employees worldwide. Sun CFO Steve McGowan said that the job cuts would result in savings of about $350 million in 2005.

In addition, Sun finally announced that vice-president of software Jonathan Schwartz has been promoted to president, replacing Ed Zander, who left Sun more than a year ago to become the president and CEO of Motorola. The appointment has been expected for quite some time. but the company didn't explain why it chose today for that announcement, too.

The timing of the "good news" Microsoft-Sun agreement could be seen as a smokescreen to help mitigate the continued bad financial and layoff news for Sun. It also takes attention away from Microsoft's own bad news from last week, when the European Union slapped the software giant with a $611 million fine for the anti-competitive actions mentioned above.

"It (Friday's announcement) just worked out this way," Ballmer said. "This was good idea 12 months ago, it's a good idea now. We just had to iron out the details. Today just happened to be the day."

The final meeting between McNealy and Ballmer to culminate the complicated deal started with a "two- to three-minute phone call" McNealy made to his longtime personal friend/hated business rival, Ballmer. "I just called Steve and said, 'Hey, it's time we stop the noise and start the collaboration. We played some golf, talked far into the night, and came up with this deal at 4:15 this morning."

Talking for long time behind the scenes

Ballmer said that "our two companies have been talking about this for more than a year. Bill Gates and (Sun CTO) Greg Papadopoulos have been meeting regularly, and Scott and I have been on the phone with each other for a long time. It's a complicated stuff. We had to build a level of trust. It took a while, because we've been kind of tied up with some other things lately," he said, alluding to the recent EU sanction.

Sun originally sued Microsoft back in 1997, claiming that Microsoft was abusing its Java technology. In fact, Microsoft came out with a competing platform called J# that was marketed as an alternative Java language that could be used to port Java applications to Windows servers. The two companies settled that suit in early 2001, with Microsoft shelling out $20 million and agreeing to phase out its older Java technology that had infringed upon Sun's IP. Sun came back two years ago with a similar IP lawsuit against Microsoft, again alleging improper use of Java and seeking to force Microsoft into updating its own Java runtime in all its Windows products.

"Our companies will continue to compete hard, but this agreement creates a new basis for cooperation that will benefit the customers of both companies," Ballmer said in a statement.

How will this new agreement affect the use of Linux in the Sun catalog? Not much, at least at this time. The term was mentioned only once in the press conference, and that was by McNealy when he explained that by adding more Windows interoperability, it gives the company more lattitude with its existing Solaris and Linux offerings.

So, with this new agreement, will McNealy stop using his favorite terms of endearment when referring to Microsoft: "that closed-lid shop," "doofuses," and "furballs"?

"The rhetoric is going to calm down from now on," McNealy said. "It's been calmer for about the last year, if you've noticed. Anyway, we're not going to argue about interoperability anymore. It's just going to be, 'Tell me why your stuff is better than theirs.' This is all to the benefit of the customers."


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