As IBM's negotiations to buy Sun Microsystems Inc enter another week, some analysts are weighing the risks in what could be the biggest U.S. technology deal this year.

As of Friday, IBM was still examining Sun's business as part of its due diligence process, and talks may extend beyond next week, according to one source who was not authorized to speak about the talks and therefore requested anonymity.

Most on Wall Street say a deal would bolster IBM's high-end computer and software business, and help ensure the survival of much-smaller Sun. But they also note that Sun's lagging business could hurt IBM's margins and derail its shift to more lucrative software and services from increasingly commoditized hardware sales.

Strategically we're a little lukewarm on it, said Edward Jones analyst Andy Miedler. Financially this could make sense. But we question how much IBM needs Sun and whether it will would be able to get better value out of Sun's software than Sun is getting.

Wachovia analyst David Wong disagreed with some views that Sun's software assets would help IBM grow.

Sun posted an 11 percent decline in quarterly revenue for its fiscal quarter ended December 28, while gross margins shrank to 41.9 percent from 48.5 percent from a year earlier. The company rose to prominence in the 1990s but never fully recovered from the dotcom bubble burst earlier this decade, and analysts say failed talks with IBM could trigger a sell-off in the shares.

Although Sun has what we consider to be interesting software intellectual property, including Solaris and Java, Sun's own revenue breakout shows that less than 10 percent of its sales are directly ascribable to software, Wong said.

We think that an acquisition of Sun would offer limited benefit to IBM.

The Wall Street Journal reported on March 18 that IBM could pay as much as $8 billion for Sun, amounting to a 100 percent premium for the high-end server computer maker. If a deal is sealed, it would be IBM's largest acquisition.

First Global research analyst Amitabh Goel earlier this week said Sun was simply too troubled and that there was too much risk for IBM to get involved.

All said and done, Sun Microsystems still remains a company with a huge cost base, with a declining revenue trend adding further to its woes, he said.

SILENCE FROM BOTH SIDES

Neither IBM nor Sun has said they are in talks, and both declined to comment on news reports of their negotiations. Some analysts said the lack of official confirmation and explanation of their strategies made it hard to assess potential benefits.

To be sure, many analysts are still upbeat that a deal could give IBM a clear lead in the server market against Hewlett-Packard Co (HPQ.N: Quote, Profile, Research, Stock Buzz) and Dell Inc (DELL.O: Quote, Profile, Research, Stock Buzz). It would also give IBM an edge against Cisco Systems Inc (CSCO.O: Quote, Profile, Research, Stock Buzz), which some see as its biggest rival in several years.

Kaufman Brothers analyst Shaw Wu said that even though Sun had not succeeded in making much profit from its new software products, he believed that they could find more demand if they were coupled with IBM's broad portfolio.

He said Java software could do for IBM, to some extent, what iTunes does for personal computer and iPod maker Apple Inc (AAPL.O: Quote, Profile, Research, Stock Buzz). I think it's a fair parallel. iTunes is not really an engine in itself but it really helps Apple sell the other stuff, Wu said.

Analysts said IBM will likely launch a major restructuring at Sun once it buys the company. That could result in more job losses at a company known for talented engineers and heavy focus on research and development, they said.

IBM has already cut several thousand jobs in recent months, and is cutting another 5,000 U.S. jobs on top of that, people with knowledge of the matter said.

But most agreed the greatest risk for Sun at the moment was in the deal falling through. Failed negotiations with IBM likely will mean that Sun will need to look for another buyer, and contend with a lower offer.

If skeletons tumble out of Sun's closet during the process, the deal could fall apart, said one technology banker familiar with the process of due diligence. We've done hundreds of transactions where it looks good on the surface, then you get in there and you back away.

Sun shares closed at $7.83 on Friday, down from a high of $9.27 struck after the deal was first reported, but still significantly above $4.97, its last closing price before the talks were first reported.

IBM likes to take the charge when doing due diligence, said one Sun shareholder, who requested anonymity. But every day that a deal doesn't happen makes me more nervous.

IBM shares fell 4.7 percent to $94.15 on the New York Stock Exchange, on a day when by comparison the tech-laden Nasdaq fell 2.6 percent.

(Reporting by Ritsuko Ando and Anupreeta Das; Editing by Gary Hill)

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