Sun shares drop on failed IBM talks

By Ritsuko Ando and Jim Finkle

NEW YORK/BOSTON (Reuters) - Shares of Sun Microsystems Inc tumbled 23 percent after it rejected a $7 billion buyout bid from IBM, leaving the smaller server and software maker vulnerable to lawsuits from shareholders nervous about its viability as a stand-alone company.

Amid expectation that the collapse of deal talks with IBM could put pressure on Sun Chief Executive Jonathan Schwartz, Sun said in an e-mailed statement on Monday that it would stand by its leadership team and growth strategy.

While some on Wall Street held out hopes for bargaining to resume, a source with knowledge of the matter said that talks broke down over the weekend after Sun turned down International Business Machines Corp's offer of up to $9.40 per share.

Sun shares fell to $6.56 from their close last week at $8.49. But they remain above the $4.97 level before the talks with IBM were first reported on March 18.

Many analysts said a sale to IBM may have been the best move for Sun, which has been losing share to rivals like IBM and Hewlett-Packard Co, and the breakdown underscored Sun's significantly weaker position at the bargaining table.

"It looks like they're in somewhat of a dilemma. Its operational history of the past four to eight quarters doesn't seem to be working well for them, nor have their efforts to sell assets," said Tom Smith, analyst at S&P Equity Research. He downgraded Sun's shares to "sell" from "hold" and lowered its 12-month price target to $6 from $9.50.

Wall Street on average expects Sun to report a third straight quarter of losses, excluding special items, for the quarter ended in March, despite efforts to control costs, according to Reuters Estimates.

Banking sources say Sun has been shopping itself for the past several months, and it appears IBM was the only bidder that came forward.

Failed negotiations with IBM could mean Sun would have to contend with an even lower offer, or worse, none at all.

Some analysts said Sun could sell itself in parts to software companies which do not want, or cannot afford, the whole company. Many said such sales would likely bring in less than a sale of the whole company.

Credit default swaps insuring Sun's debt jumped to around 143 basis points, or $143,000 per year for five years to insure $10 million in debt, from around 95 basis points on Friday, according to Markit Intraday.

ANOTHER YAHOO?

Some predicted Sun could face anger from shareholders in the same way that Yahoo Inc co-founder and previous Chief Executive Officer Jerry Yang did after he rejected Microsoft Corp's $47.5 billion bid last year. Yang eventually stepped down under strong criticism.

"We sure hope that shareholders don't experience a Yahoo," said Keith Wirtz, president and chief investment officer at Fifth Third Asset Management, which owns both Sun and IBM shares.

Sun declined to confirm or comment on the latest developments, but said it would stand by its leadership team. Schwartz had replaced Scott McNealy as CEO in 2006. McNealy, one of the founders of the Silicon Valley start-up, stayed on as chairman.