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Former Finance Chief's Return, Board Activism May Signal End Of Chairman's Tenure as CEO

Scott McNealy, chairman and chief executive of Sun Microsystems Inc., has often had a testy relationship with Wall Street -- and that has weighed on the company's stagnant stock price. But the situation could be changing.

The first sign is the return of Michael Lehman, who retired in 2002 as Sun's chief financial officer but assumed the post again in February. The appointment helped boost Sun's stock by more than 20%, analysts say, on the theory that Mr. Lehman would help push through large-scale head-count reductions that Wall Street has long sought and Mr. McNealy resisted.

And now, some former Sun executives and others are buzzing about the possibility that Mr. McNealy may give up the CEO title, most likely to Jonathan Schwartz, the company's president and chief operating officer. The timing of any change isn't clear, though some speculate that a change could be disclosed as early as the company's earnings announcement, slated for Monday, or some months later.

Asked if he is planning to step down, Mr. McNealy characterized the possibility as merely a rumor, without directly answering the question. "That rumor is about 22 years old and still chuggin," he wrote in an email.

Certainly, there have been many wrong guesses in the past about Mr. McNealy, who has come under fire for the Silicon Valley company's erratic profits and failure to boost revenue. Sun's board has appeared solidly behind Mr. McNealy, who repeatedly has said he has no plans to leave the computer maker.

Several factors are renewing questions about the company's plans. For one thing, analysts say, Sun's board has been more active lately in pressing for improved performance.

Meanwhile, Mr. Lehman has become Sun's new front man with the financial community, meeting with investors in public and private, says Toni Sacconaghi, an analyst at Sanford Bernstein. Analysts expect Mr. Lehman to deliver a detailed financial plan for the fiscal year beginning in July. He also is expected to resume the practice of giving quarterly financial guidance, addressing another irritant for analysts.

Mark Stahlman, an analyst with investment bank Caris & Co., argues that one more step is required -- to clarify the responsibilities of Mr. McNealy and other top managers by the start of the next fiscal year. "I think Scott has to step aside so there is no confusion," he says.

Mr. Stahlman wrote a research note about the possibility of a management change in early March. He argued that Mr. McNealy has fixed Sun's most serious problems and could leave while claiming victory of a sort.

That prediction, Mr. Stahlman says, was largely based on conversations more than a year earlier with people close to Sun. Since he wrote the note, he adds, other knowledgeable people have come forward to say a succession plan is in the works, with Mr. McNealy remaining chairman. Mr. Stahlman has a "buy" rating on Sun. Neither he nor Caris hold any Sun shares.

One person interviewed for the top finance job at Sun says he came away convinced that Mr. Schwartz was the clear favorite to succeed Mr. McNealy. After speaking with both men, he says, "I walked away thinking, 'This [CEO] job is taken.' "

Mr. Sacconaghi remains unconvinced about any impending change, noting that Mr. McNealy stated his commitment to remain at the helm as recently as the company's analyst meeting in February. "I'm happy to hear that the board appears to be demanding a plan for growth and profit," Mr. Sacconaghi says. "I think it's long overdue. But I don't think we know any more than that."

Mr. Sacconaghi, who holds no Sun shares, has an "underperform" rating on the stock. Bernstein and its affiliates hold more than 1% of Sun's shares. It does no investment-banking business with the company.

Sun has gone through big transitions before. The Santa Clara, Calif., company, founded in 1982 to make desktop workstations, successfully shifted its emphasis to server systems and enjoyed explosive growth during the Internet boom of the late 1990s. But Sun's sales went into a tailspin when telecommunications companies and financial-service firms stopped buying its hardware. Analysts expect the company to post a loss for the fiscal year ending in June and the following 12 months.

The one constant has been Mr. McNealy, who has been at the helm since 1984. Rebuffing calls to reduce research-and-development spending, Sun has improved the servers based on its internally designed Sparc chips, added machines that use sophisticated chips from Advanced Micro Devices Inc., and adapted its highly regarded operating system to run on that hardware. Sun also settled a long legal battle with Microsoft Corp., reaping nearly $2 billion.

But Sun's revenue remains 40% below its peak during the Internet bubble. Its stock price -- a far cry from its 2000 high of $64 a share -- has bounced for three years between about $3.25 and $5.80. In 4 p.m. composite trading on the Nasdaq Stock Market Sun shares closed yesterday at $4.95, down three cents, giving the company a market value of about $18 billion.

A particular bone of contention with Wall Street has been Sun's cost structure. Harry Blount, who follows Sun for Lehman Brothers, estimates that Sun's operating expenses -- including R&D as well as spending for sales and administration -- are about 47.8% of revenue. The comparable measure at EMC Corp., a storage-system company with operations that he regards as comparable, is 35.8%, he estimates.

International Business Machines Corp. and Hewlett-Packard Co. expenses, respectively, are 26.4% and 15.7% of revenue, he says. Mr. Blount has a "hold" rating on Sun shares. Neither he nor Lehman own Sun shares, but Lehman provides securities-related services to Sun.

While Sun has no price-to-earnings multiple now, Mr. Sacconaghi of Bernstein Research notes that Sun shares trade at 1.3 times its revenue, compared with about 1 times sales for rival H-P, 1.1 for Dell Inc. and 1.4 for IBM.

Caris's Mr. Stahlman predicts Sun's stock would rise if Mr. McNealy gave up the CEO title. The market's potential reaction regarding Mr. Schwartz -- a 40-year-old known more for pronouncements about technology directions than operational skill -- is less clear.

Sebastian Thomas, head of U.S. technology research for Sun shareholder RCM Capital Management LLC., which manages about $120 billion globally, predicts that investors would react "pretty favorably" to a management change if the company's revenues remained stable or grew.

But Charles Lemonides, chief investment officer for ValueWorks LLC, an investment firm in New York that holds Sun stock and manages $225 million, argued that improved operating results are the most important factor for the stock. "It would be better for the shares to see that under existing management," he says.

source:http://online.wsj.com/public/article/SB114550160277730845.html