Jini may not have yet enabled your toaster to talk to your dishwasher, as some have jokingly described the software's capabilities, but thanks to the company's highly profitable computer systems -- its workstations, servers, and network storage products -- Sun has continued to produce tremendous revenue and profit growth. The company's slogan -- that it's the "dot" in the dot-com -- may be standard Internet hype, but for Sun there is a lot of truth to it.
The company is very highly valued, but such was the case during the last Duel, and its shares are now worth 265% more. Of course this pace won't last long, but the company will probably be highly valued for some time, given its 25%-plus growth rates, high free cash flow, and a central role in building the infrastructure of the Internet. In fact, I would argue that the company is a Rule Maker, and as my worthy bearish counterpart (and Rule Maker co-manager) Rob Landley knows, Rule Makers cost money.
For those unfamiliar with the company, Sun is primarily known for its high-end enterprise servers, which literally serve pages for leading websites such as eBay (Nasdaq: EBAY), CNN Interactive, 1-800-Flowers (Nasdaq: FLWS), and others. In addition, the company also makes midrange servers, workstations, and network storage products. In the most recent quarter, the company's computer systems and storage segment provided 75.6% of revenue, while Sun's enterprise services division accounted for 14.3%, and the rest came from "various software and other miscellaneous divisions," as the company's most recent 10-Q puts it. This latter category includes the company's proprietary operating system Solaris, as well as its Java programming platform and Jini technology.
Growth in all these areas remains strong. The company recently beat out competitors IBM (NYSE: IBM) and Hewlett-Packard (NYSE: HWP) in order to renew its contract with eBay to provide servers, software, storage, and support services. eBay's president of technologies noted that "Sun was without a doubt the best offer we had when you factor in all the pieces of the equation." The company's Java software is moving into portable devices such as cell phones and pagers, and is even being used by American Express' new smart card. Since shipping in December, Java's most recent enterprise-level incarnation has been licensed by Oracle (Nasdaq: ORCL), Compaq (NYSE: CPQ), Hitachi (NYSE: HIT), BEA Systems (Nasdaq: BEAS), and Sybase (Nasdaq: SYBS), among others.
All this is clearly evident in Sun's standout financial statements. In the company's fiscal third quarter, which ended in March, revenue clocked in above $4 billion for the first time, a 35% jump from the previous year. Earnings hit $436.2 million, representing 49% growth, while earnings per share (EPS) were up 44% to $0.26. On a trailing 12-month (TTM) basis, revenue is up 27.5%, net income is up 68.9% and EPS is 62.5% higher.
In fact, let's put the company through a Rule Maker evaluation and see how it qualifies. I'm going to skip the more subjective criteria, and move straight to the quantitative metrics.
The first of these is sales growth over 10%, which Sun easily meets, given its 27.5% TTM rate mentioned earlier. Next, the Rule Maker portfolio wants gross margins of 50% or greater. Sun has cleared that hurdle for over two years, and posted gross margins of 52.2% in its most recent quarter. While Sun would still be a great company even with margins a few percentage points less, such high gross margins illustrate Sun's pricing power, the value the company adds to its hardware with its software and services, and the operating room the company has should any competitor attempt to undercut them on price.
Next, we turn to net margins, where Rule Makers are expected to vault over a 7% bar. Sun clears it easily, with net profit margins of 10.6% in the first nine months of its fiscal year 2000. Rule Maker investors like to see these metrics improving, and Sun is doing so: Last year, net margins were barely above 8%.
The company's cash-to-debt ratio of 1.47 is technically below the Rule Maker's preferred 1.5, but only because Sun moved $1.9 billion of its cash into long-term securities. With those sums included, the company's war chest stands at $5.05 billion, and its cash-to-debt ratio vaults to 2.4. Sun is a cash-rich company and capable of making any acquisitions or funding any new initiatives it sees fit to undertake.
The last two metrics reveal how the company became cash-rich: Its cash-management and cash-generating abilities are clearly of Rule Maker quality. Sun's Flow Ratio is a very respectable 1.10, below the required 1.25 criterion. The company is headed in the right direction as well, as its Flowie last year stood at 1.2. This improvement reflects Sun's ability, despite its rapid growth, to ably manage its working capital.
In addition, the company's Cash King Margin -- like a true Rule Maker, higher than its net margin -- stands at 12.7%, easily meeting the 10% requirement. As explained over in the Rule Maker criteria, this number indicates that for every dollar Sun earns in sales, 12.7 cents ends up as free cash flow, and can be used to further grow the business, repurchase shares, or perhaps for dividend payments in the future.
Sun easily meets all the Rule Maker Portfolio's quantitative criteria. For a more comprehensive Rule Maker evaluation, based on the company's second-quarter report, check out SamIAm99's post on the Rule Maker board, which puts Sun in the top tier of Rule Makers.
As a result, I eagerly await Rule Maker manager Rob Landley's explanation of why he is bearish on the company. Knowing Rob's programmer background, I bet he has some kind of techie-programmer beef with the company, but we'll see.
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