March 19 (Bloomberg) -- Sun Microsystems Inc. co-founder Scott McNealy, known for deriding the technology of more- established companies, may see his business become part of one of the oldest: International Business Machines Corp.

Sun, founded in 1982, was so crucial in helping build the Internet’s infrastructure that it once billed itself as the “dot in dot-com.” The success of Sun’s chips, servers and software lifted sales to more than $18 billion by 2000 and gave McNealy the platform to insult rival products from IBM, Intel Corp. and Microsoft Corp.

“They were the de facto standard on the Internet -- everybody went with them,” said Daniel Morgan, a fund manager at Atlanta-based Synovus Securities Inc., which owns IBM shares. “Now it’s looking like he’s going to be part of what he hated.”

IBM is in talks with Sun about an acquisition, according to people familiar with the matter. Shawn Dainas, a spokesman for Santa Clara, California-based Sun, declined to comment, as did IBM spokesman Ron Favali.

After the dot-com bubble burst, Sun’s sales and profit growth stalled. Customers shifted orders to rivals such as Hewlett-Packard Co. and IBM. The competitors provided cheaper machines based on Intel chips and Microsoft Windows software -- two technologies McNealy had ridiculed.

Lightning Rod

“Scott’s been a lightning rod for a long time, but it hasn’t helped his business,” said Peter Sorrentino, a fund manager for Huntington Asset Advisors, which oversees $13 billion, including IBM shares.

An acquisition of Sun also may start a trend in the technology industry, as cash-rich companies expand their product lines. Cisco Systems Inc. said today that it plans to buy Pure Digital Technologies Inc., a maker of flip-open camcorders, for $590 million in stock.

“We’ll likely see a wave of consolidation in technology as tech companies look to strengthen and complement their product offerings,” said Brian Webber, global head of technology investment banking for UBS AG in San Francisco. “Because of current low valuations, this is an ideal time for larger tech companies with a lot of cash on their balance sheets to make strategic acquisitions.”

The technology industry may follow the same pattern as health care, where Pfizer Inc.’s $64 billion purchase of Wyeth is spurring consolidation, said Jeffrey Raich, co-founder and managing director at Moelis & Co. in Los Angeles.

“The deal could instill confidence in other buyers,” Raich said.

Amazon.com, Google

Acquirers will be hunting for companies to build up their presence in so-called cloud computing -- the concept of delivering software and computing power on an as-needed basis. That market will more than double to $42 billion by 2012, not including sales of related equipment, said Vernon Turner, an analyst at Framingham, Massachusetts-based research firm IDC.

Amazon.com Inc., Salesforce Inc. and Google Inc. are already offering cloud-computing services, by providing access to software that they manage from their own data centers. Sun announced plans yesterday to offer two cloud services later this year.

Providing the services requires the integration of computer hardware, software, networking switches and storage, said Brian Marshall, an analyst at Broadpoint Amtech Inc. in San Francisco. Right now, no company owns all the pieces it needs to do these projects solo, he said. That may prompt some of them to make acquisitions.

Dot-Com Boom

The three leading companies in data-center equipment are Cisco, Hewlett-Packard and IBM, Marshall said. Hewlett-Packard could buy F5 Networks Inc. or Brocade Communications Systems Inc. to bolster its switching capability. Or Cisco, the biggest maker of networking equipment, could buy EMC Corp. to get storage equipment and software, he said.

“Tech companies have learned a lesson from the 2001-2002 crisis,” said Chris Gaertner, a managing director of technology investment banking at Bank of America Corp.’s Merrill Lynch. “They saw that only the larger companies with varied product portfolio were best able to weather the storm.”

Propelled by surging dot-com spending, Sun’s sales almost doubled between 1998 and 2000. When the bubble burst, the company didn’t adapt quickly enough to industry-standard equipment.

Open Software

Businesses embraced machines with Intel chips and Microsoft software. The Linux operating system also won converts. Linux is open-source, meaning it’s developed freely by a community of developers. Sun clung to its own Solaris operating system and more expensive hardware.

In the 1980s, Sun became successful by doing just the opposite. To compete with Apollo Computer Inc. for workstation customers, it set out to make computing less costly and more open. Sun allowed customers to add their own features and software -- something Apollo didn’t do, said Ray Rothrock, a venture capitalist at Menlo Park, California-based Venrock. He was one of Sun’s first employees.

McNealy, who founded Sun with Vinod Khosla, Andreas Bechtolsheim and William Joy, had a saying: Technology has the shelf life of a banana. He built a team of aggressive leaders to stay on top of trends, including Eric Schmidt and Carol Bartz, the future CEOs of Google and Yahoo! Inc.

Windows ‘Hairball’

McNealy, 54, publicly criticized rival technology, calling Microsoft’s Windows operating system a “hairball.” He dubbed IBM’s Regatta server “Regretta” and Intel’s Itanium chip “Itanic.”

By the time McNealy stepped down as CEO in April 2006, Sun had racked up four years of losses totaling $4.51 billion. He passed the reins to Sun’s president and chief software executive, Jonathan Schwartz.

“McNealy didn’t see the whole thing until it was way too late,” said Rob Enderle, president of the research firm Enderle Group in San Jose, California.

McNealy stayed on as chairman. He and Schwartz each earned $1 million in salary last year, according to a company filing.

Sun has posted losses in three of the past four quarters, and analysts predict another loss in the current period. The company announced plans in November to cut 5,000 to 6,000 workers, as much as 18 percent of its global workforce.

Schwartz’s Regrets

In a blog posting last week, Schwartz, 43, said he wished he had made Sun’s Solaris operating system more widely available in the late 1990s. He also regretted stopping a project to adapt it for use on Intel-based machines, focusing instead on Sun’s own Sparc chips.

“That mistake destroyed a generation of Solaris developers, and accelerated the rise of alternatives to traditional Sparc hardware,” Schwartz said.

Still, Sun has taken steps toward using rival technologies.

In April 2004, McNealy shared the stage with Microsoft CEO Steve Ballmer to announce that the two companies had settled a decade-long antitrust suit. In 2007, Sun began selling servers that run Windows.

One of Schwartz’s first moves as CEO was to sign a deal to build servers on Intel chips and offer machines that competed with those from IBM, Hewlett-Packard and Dell Inc.

Sun’s change away from championing its own products at any cost may make the integration of two former enemies easier, said Michael Shinnick, a fund manager at Wasatch Advisors Inc. The South Bend, Indiana, firm owns 1.3 million shares of Sun, part of $4.5 billion under management.

Changing Attitude

“The culture transformation has been under way for the last couple of years,” Shinnick said. “It’s changed from ‘us against the world’ to ‘we’re going to have to play.’”

Meshing Sun’s culture with IBM’s may be a challenge. At Sun, engineers do what they want and ask for permission later, said James Staten, an analyst with Forrester Research in Foster City, California. IBM, known as Big Blue, is seen as more old- fashioned. The Armonk, New York-based company got its start as a maker of punch-card machines in the 19th century.

“For this merger to work, there’s a lot of technology that Sun owns that needs to be turned Blue,” Staten said. “If the people at Sun aren’t happy, they can’t accomplish that.”

To contact the reporters on this story: Ian King in San Francisco at ianking@bloomberg.net; Tim Mullaney in New York at tmullaney1@bloomberg.net; Connie Guglielmo in San Francisco at cguglielmo1@bloomberg.net

Last Updated: March 19, 2009 13:56 EDT