Southeastern Could Lose $500 Million on IBM-Sun Deal

Sun Microsystems Inc.’s biggest shareholder could face a loss of more than $500 million on its investment if Sun sells to International Business Machines Corp. under terms discussed last week.

Southeastern Asset Management Inc. paid a total of $2.13 billion, or an average of $13.25 a share, for its 22 percent stake in Sun, according to a January regulatory filing. A deal at $9.40 a share would mean a payout of about $1.5 billion for Southeastern.

Southeastern’s situation highlights the dilemma for some Sun investors: whether to push for the takeover and accept some losses, or count on Sun Chief Executive Officer Jonathan Schwartz to turn around the business. Sun’s shares had fallen about 80 percent in the two years leading up to March 18, when reports of IBM’s $7 billion offer emerged.

In addition to the stock holdings, Southeastern’s Longleaf Partners Fund paid $10.1 million for call options that give it the right to purchase 5 million Sun shares at $10 each. Those options, now “underwater,” expire in January 2010.

Southeastern, the investment advisory firm run by Mason Hawkins and Staley Cates, first reported investing in Sun in the third quarter of 2007, when the stock traded at an average price of $20.99 a share. Jason Dunn, a vice president at the Memphis, Tennessee-based firm, declined to comment.

IBM, the world’s largest computer-services company, offered $9.10 or $9.40 a share for Sun, according to differing accounts of the negotiations. That’s almost double the $4.97 Sun’s shares traded at on March 17, the day before the acquisition reports. Sun’s board unanimously rejected the offer last weekend, one person familiar with the matter said.

Board Meeting

Sun’s board was scheduled to meet yesterday to discuss the next steps for the company, according to a person familiar with the matter. Kristi Rawlinson, a spokeswoman for Sun, said the company doesn’t comment on the activities of its shareholders.

Sun, based in Santa Clara, California, rose 2 cents to $6.68 at 4 p.m. New York time in Nasdaq Stock Market trading.

In October, Southeastern announced its switch from being a passive to active investor in Sun. That meant it could have more involvement in the management and governance, and be able to talk with other companies about “transactions of a significant nature,” Southeastern said at the time.

On Dec. 8, Sun, whose stock was trading at $3.83, let Southeastern pick two new independent directors for its board. Hawkins and Cates said in a letter to investors later that month that Sun needed to cut costs after losing revenue from financial-services firms. The fund managers estimated that Sun’s cash amounted to more than half its market value.

Sun’s Losses

Sun posted losses totaling $1.89 billion in the past two quarters after customers cut back purchases of server computers, which account for almost half of Sun’s sales. Sun is now headed for its biggest annual loss in six years.

Some shareholders have already decided to sell their holdings. Relational Investors LLC, once Sun’s third-largest holder, sold its 4.7 percent stake on concern that talks with IBM would break down, Ralph Whitworth, founder of San Diego- based Relational Investors, said this week in an interview.

Whitworth said he may buy Sun’s shares again if they fall further and executives show a “strong commitment to address their cost structure.”