Sun MicroSystems Case Study (Excel knowledge required)

Sun Microsystems

Questions:

1. Is Sun Microsystems a good “Strategic” fit for Oracle? Why or why not?

2. Prepare a Discounted Cash Flow Analysis to Value Sun on a “stand alone’ basis (EXACTLY LIKE WE DID FOR NIKE).

A. What rate of return should Oracle require on the acquisition of Sun (see Tips and Pointers below)?

B. What base cash flows do you forecast?

C. What is your estimate of Terminal Value?

D. What is the Enterprise Value of Sun? What is the Equity Value? Per share value?

3. Separately, conduct a “Comparables” analysis to value Sun (see Tips and Pointers below). What economic

fundamentals are reflected in the multiples?

4. Identify any synergies and conduct a sensitivity analysis to estimate the effect of synergies on enterprise value?

5. What is the per share Value of Sun it becomes part of Oracle, i.e., with the synergies?

6. If a competing bidder appears, how a high a price should Oracle be willing to offer?

Tips and Pointers:

1. For the DCF analysis please note the following as a brief review. First calculate the WACC for Sun as follows:

A. Follow the CAPM to calculate the Required Return on Equity.

B. Note the risk free rate is 2.82% which is the 10 Treasury bond rate from case Exhibit # 10.

C. Note Exhibit 9 of case contains relevant financial information for Sun and its peer group companies.

D. Sun’s pretax cost of debt is 11.42%; based on its credit rating.

E. Once you calculate, find and utilize the above, then you can calculate WACC for Sun (using the

following additional information).

F. The tax rate is 35% and the EMRP is 6%.

2. In order to complete a valuation analysis using “COMPARABLES” information please note the financial data in

case Exhibit 9 for the “pure play” hardware companies; namely:

Apple

Dell

Hewlett-Packard

Intel

International Business Machines and

Sun

The above are the “Comparables” to be used. You must calculate each company’s debt / value (& equity /

value). The final pieces of financial information that is needed to calculate the industry wide WACC are the

respective costs of equity, Re, as well as cost of debt, Rd.

Please note that based on each company’s credit rating their respective costs of debt are follows:

Company Cost of debt

Apple 0 N/A

Dell 6.35%

Hewlett-Packard 6.35%

Intel 6.27%

International Business Machines and 6.27%

Sun 11.42%

Hence you can calculate each company’s Re (cost of equity), then calculate each company’s WACC (using their

levered betas).

Take the median WACC (of the 5 peer companies) and use it as alternative to Sun’s WACC, to discount Sun’s

cash flows. Hint: this will give a higher stand-alone value for Sun.

Utilizing the two different discount rates developed (Sun’s WACC vs industry-wide “comparable” discount rate)

you can develop a range for the stand alone-value of Sun.

With respect to the projections, please use case Exhibit #’s 11, 13 AND 14 to prepare them, using the same

approach that we used for Nike. The projections extend through 2014; you will need to calculate and

incorporate a Terminal Value. The TV growth rate should equal the risk-free rate of 2.82%.

Note the “Operating Income” corresponds to EBIT. You must apply the 35% tax rate to this to arrive at NOPAT.

Obviously the other 2 bullets on our famous Free cash flow slide then need to be incorporated. Case exhibit 14

gives a great deal of this information, e.g., keeping PPE at 12% of sales after 2009. Correspondingly the NWC

should change in proportion to Revenue. This should be kept at 25.9% of Net Revenue.

Finally, as we discussed, you must set up a similar analysis soley for the “integration” costs / synergies value.

This should be based on Oracle’s expectations as follows:

I. Pre-tax Integration costs of $1.1 Billion. This will be incurred $750 million in 2010 and $350 million

in 2011.

II. A “Loss” of $45 million in revenue right after the merger due to customers moving away from the

newly-formed company; and

III. Pretax profit increase of $900 million per year beginning is 2011.

Please be sure to tax effect the 3 items above; and to apply a Terminal Value exactly as you did for the stand-

alone value of Sun. The value derived will be additive to the stand alone per share value derived above.

Note there is a free student spreadsheet available once you download the case. This

will help you to set up your projections and derive free cash flow / ultimate

valuation(s) for Sun.

Once the “Enterprise” value is derived (as we did for Nike) you should be sure to

remember to subtract the book value of debt as well as add the “Excess” cash of

$1,185 (in millions of US Dollars which is invested in “Marketable Debt Securities” on

the 2009E Sun balance Sheet in case Exh. # 11).