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Long-time strategic partners Hewlett-Packard Co. (HPQ) and Oracle Corp. (ORCL) could meet in court over a technological dispute. Though lawsuits encircling patent infringements and violation of contract terms are common in the tech sector, we think that the legal battle between these two giants will be a major issue.

Some Background

In March 2011, Oracle decided to abandon the development of software needed to run itanium chip-based servers. The cessation was based on the assumption that Intel Corp. (INTC) could stop the manufacture of itanium chips due to its feared obsolescence.

Oracle’s decision came as a major blow to H-P -- the main user of Itanium chips in servers needed to run large corporate databases and other demanding computing tasks. Without Oracle’s support, H-P will have a hard time marketing its host of server offerings.

The announcement miffed Intel, which denied any plan of dumping the itanium processor. Instead, the company informed that it has long-term plans for the itanium-architecture and is developing two itanium chips, namely Paulson and Kittson.

But Oracle stood firm. It maintained that itanium chips were expensive and could specifically be used in only a few applications. Therefore, Intel would scrap the itanium plan and focus on a range of widely accepted processors. It also hit back at Intel, claiming that the chip giant was being dishonest.

Despite repeated requests, Oracle stuck to its decision. Consequently, H-P sued Oracle for breach of contract in June 2011. H-P also alleged that Oracle was persuading customers to replace their itanium-based HP servers with Sun servers (Oracle acquired Sun Systems in January 2010).

The contract in question related to incessant software support from Oracle for H-P’s server systems. However, Oracle has denied the existence of any such contract.

Current Scenario

Following Oracle’s announcement that it would withdraw software support for itanium, sales of Hewlett-Packard’s itanium-based Integrity and Superdome machines, which it describes as “business critical systems,” have been falling. Sales of Itanium hardware fell 23% to $421 million in Hewlett-Packard’s fiscal second quarter ended April 30. Oracle’s decision could thus prove to be an irrevocable loss to its server business.

To counter this loss, H-P is now demanding a court order to compel Oracle to restore its software support. H-P is also demanding damage charges of $500.0 million for the loss suffered in the interim period.

In case this ruling is not passed, H-P has plans to seek $4.0 billion from Oracle in damages.

What Lies Ahead?

We believe the prime consideration would be whether any material contract existed at all between the two. This could be a grey area given Oracle’s outright denial. On the other hand, H-P remains a leading player despite recent pressures. Therefore, it is unlikely to make a false claim.

Whatever the outcome, it is sure that both Oracle and H-P will be more aggressive in grabbing server market share. It isn’t just the companies that will be affected, the end-users will also be in deep water. Customers using H-P’s itanium chip-based server will have to search for better alternatives or restructure their IT systems.

Oracle is not the first to dump the idea of itanium; it actually followed in the footsteps of Red Hat Inc. (RHT) and Microsoft Corp. (MSFT).

The technology was jointly developed by Intel and H-P way back in 1994. But the high-performance, high-end chip was tailor-made for high-end servers. The product was slow to ramp up and was suppressed by the wide acceptance of Advanced Micro Devices Inc.’s (AMD) 64-bit x-86 chip. Notably, in 2009, Unisys Corp. (UIS), an Intel customer shifted from itanium to the x86-based Xeon server chip family.

Conclusion

Considering the above situation, we think that it might be difficult for H-P to carry on its itanium-based server business profitably. For the time being, we have to take a “wait and see” approach as H-P’s fate is now tied to the court’s decision.

Currently, H-P has a Zacks Rank #3, implying a short-term Hold recommendation. Oracle, despite the case that it recently lost to Google Inc. (GOOG), has been assigned a Zacks Rank #2, implying a short-term Buy recommendation.

 
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