"I am the great and powerful Oz…pay no attention to that man behind the curtain." These famous lines, uttered by L. Frank Baum’s cornered huckster who had made promises he could not keep, is eerily coming to life in the persona of Scott McNealy and Sun.

Like the "Wizard," McNealy has ruled over a kingdom through perceived might and overt bombast. His subjects, and the other residents of Oz, have revered and respected him more for what he might do, rather than for what he actually does. Few get inside the inner sanctum, because the Wizard knows that they just might find out his darkest secret – that while he once had power, he’s now doing it all with mirrors.

The Fading Emerald City
Over the last two years, Sun’s Emerald City has been losing that brilliant green luster. Where there was once over $7 billion in cash in 2000, there is now a somewhat illiquid $5.2 billion. Where there was once $18 billion in revenues, there is now $12 billion. Where there was once a 50% year-over-year growth rate, there are now 46% declines. During a walk across Sun’s financial landscape, one only finds the fading glow of what was.

More and more, members of the financial community have been peeking into Sun’s closets, and coming away frightened with what they find. In just the past year, over 22 different firms have downgraded Sun’s stock. Analysts have seen Sun’s once-mighty gross margins shrink from 52% to 41%, and watched as other vendors zoomed past with better technology and more compelling value propositions.
History now shows that while the technology market soured in late 2000, the Wizard sat back confidently and waited for his subjects’ tribute money to keep pouring in. However, he had grossly overestimated the extent of his hegemony, not to mention his ability to keep everyone distracted from inconvenient facts. As the curtain’s flawed construction obscured less and less reality, the Wizard has continued to blow more and more smoke, refusing to admit the obvious fact that the Yellow Brick Road has been redeveloped and is now pointing to the lands of Wintel and Linux. "As many successes as Sun has had," noted Laura Conigliaro of Goldman Sachs in a recent report, "there are now also enough lapses to suggest that…Sun probably needs to reassess its decision-making process."

Suddenly, the Wizard’s subjects realized that they did not really need the Solaris magic, and they began to strike out on their own. Some have remained, but few new arrivals have joined them during the past two years. The Wizard has refused to accept responsibility for these defections, preferring to repeatedly lash out stridently at the Warlock of Windows, which only served to further turn people against him. "We believe the real question (about Sun) is not viability but relevance," says Merrill Lynch analyst Steve Milunovich.

Sinking Foundation
Like the engineers watching Venice sink, analysts have considered Sun’s financial foundation and found that the slab is cracking and that wholesale repairs are desperately needed. Given the weight of the bloated Emerald City and the cavalier attitude of the Wizard, most do not expect anything more than a little spackle.
"A huge problem for Sun is their technology map going forward," said one historically pro-Sun analyst who did not want to be named. "They have sacrificed their cash cow low-end business to keep their high-end business afloat, and now everyone else has passed them with better offerings." Sun has also insisted on developing proprietary 64-bit microprocessors, operating system, middleware and desktop applications, thereby dispersing resources and casting doubt on its long-time proprietary strategy.
The financial figures back this up, as Sun’s stubborn insistence on sustaining R&D has significantly raised these expenses as a percentage of revenues from 10.4% in FY2000 to 14.7% in FY 2002 and the current level of 15.9%. While technology leadership certainly requires innovation, Sun has spread itself across so many initiatives (N1, X86 support, Linux desktops, StarOffice) that cutting back has become too painful.

New revenues would make the pain subside, but Sun has had a difficult time finding these new avenues. Historically, Sun derived 60-65% of revenues from telecommunications and financial services. "The issue that jumps out at me is ‘where are new revenues going to come from’," said the analyst. "They had a lot of time and effort invested in telecom, and that industry has imploded."
While many of its compatriots have ramped up their services offerings to help compensate for lagging hardware revenues, Sun has shown no interest in increasing its services team or in looking to services for greater revenue production. Services accounted for 27% of total Sun revenues in 2002, with minimal, if any, growth anticipated given the sharp workforce reductions upcoming in the next year.

Cashing Out?
When talking to customers, one of Sun’s constant messages has been its impressive cash position. While its coffers still contain $5.2 billion, it is interesting to note that over $1.5 billion of that is permanently invested in foreign tax jurisdictions, meaning it could not be repatriated to the U.S. without substantial tax liability and/or loss of equity. According to its own disclosures, Sun burned over $2 billion from its war chest during the past two years, plus an additional $600 million in just the past quarter. With charges from layoffs and prior restructurings looming as well, Sun could burn through an additional $350 million in cash very quickly. While there is no imminent prospect of cash shortages, Sun might have to find credit to help it with financing its structural revisions, and creditors aren’t likely to see those large foreign positions.

End of the Rainbow
Despite getting battered on every side of the market, Sun continues to defiantly stick out its chest and challenge the competition to beat its technology. Unfortunately for Sun, more and more of their competitors have been able to do just that, enticing former Emerald City residents with lower-cost, non-proprietary hardware that meets their enterprise needs. The curtain is now ripped open and the dilapidation of a once mighty kingdom is laid bare before the world. And while the Wizard stamps his feet and pounds his control panel to distract the masses, an ever-increasing number of residents are finding there are far better places to call home.