COBALT NETWORKS INC
STOCK OPTION AGREEMENT
<DOCUMENT>
<TYPE>EX-10.1
<SEQUENCE>3
<FILENAME>0003.txt
<DESCRIPTION>STOCK OPTION AGREEMENT
<TEXT>

<PAGE>

                                                                    EXHIBIT 10.1

                                                                  EXECUTION COPY


                        FORM OF STOCK OPTION AGREEMENT

     THIS STOCK OPTION AGREEMENT (this "Agreement") is made and entered into as
                                        ---------
of September 18, 2000 by and between Sun Microsystems, Inc., a Delaware
corporation ("Parent"), and Cobalt Networks, Inc., a Delaware corporation (the
              ------
"Company").
--------

                                   RECITALS:

     A.  Parent, Merger Sub (as defined below) and the Company have entered into
an Agreement and Plan of Merger and Reorganization (the "Reorganization
                                                         --------------
Agreement") which provides for the merger (the "Merger") of a wholly-owned
---------                                       ------
subsidiary of Parent ("Merger Sub") with and into the Company, pursuant to which
                       ----------
all outstanding capital stock of the Company will be converted into the right to
receive Common Stock of Parent. Capitalized terms used but not otherwise defined
herein shall have the respective meanings ascribed thereto in the Reorganization
Agreement.

     B.  As a condition to Parent's willingness to enter into the Reorganization
Agreement, Parent has requested that the Company agree, and the Company has so
agreed, to grant to Parent an option to acquire shares of Common Stock, par
value $0.0001 per share, of the Company ("Company Shares"), upon the terms and
                                          --------------
subject to the conditions set forth herein.

                                   AGREEMENT

     NOW, THEREFORE, in consideration of the foregoing premises, the mutual
covenants, promises and representations set forth herein and in the
Reorganization Agreement, and for other good and valuable consideration, the
receipt and sufficiency of which are hereby acknowledged and accepted, the
parties hereto hereby agree as follows:

     1.  Grant of Option.  On the terms and subject to the conditions set forth
         ---------------
herein, the Company hereby grants to Parent an irrevocable option (the "Option")
                                                                        ------
to acquire up to a number of Company Shares equal to 19.9% of the issued and
outstanding Company Shares as of the first date, if any, upon which an Exercise
Event (as defined in Section 2(a) hereof) shall occur (the "Option Shares"), for
                     ------------                           -------------
a purchase price of $57.63 per share (the "Exercise Price").
                                           --------------

     2.  Exercise of Option.  The Option may be exercised by Parent, in whole or
         ------------------
in part, at any time or from time to time if the Reorganization Agreement is
terminated pursuant to Section 7.1(b), Section 7.1(d) or Section 7.1(e) thereof,
and an event causing the Termination Fee to become payable pursuant to Section
7.3(b) of the Reorganization Agreement occurs (any of such events being referred
to herein as an "Exercise Event").  In the event that Parent shall elect to
                 --------------
exercise the Option pursuant to this Section 2, Parent shall deliver to the
                                     ---------
Company a written notice (each an "Exercise Notice") specifying the total number
                                   ---------------
of Option Shares that Parent wishes to acquire at such time pursuant to the
exercise of the Option.
<PAGE>

     3.  Closing of Option Exercise.
         --------------------------

          (a)  Each closing of a purchase of Option Shares pursuant to the
exercise of the Option (a "Closing") shall occur on a date and at a time, prior
                           -------
to the termination of the Option pursuant to Section 4 hereof, designated by
                                             ---------
Parent in an Exercise Notice delivered to the Company at least two (2) business
days prior to the date of such Closing, which Closing shall be held at the
principal offices of the Company. Subject to the terms of Section 3(b) hereof,
                                                          ------------
at any Closing, the Company shall deliver to Parent a single certificate in
definitive form representing the number of Company Shares designated by Parent
in its Exercise Notice, such certificate to be registered in the name of Parent
and to bear the legend set forth in Section 10 hereof, against payment by Parent
                                    ----------
to the Company of the aggregate purchase price in cash for the Company Shares so
designated and being purchased at such Closing by delivery of a certified check
or bank check, or wire transfer of immediately available funds to an account
designated by the Company in writing.

          (b)  The Company shall not be required to issue Option Shares to
Parent pursuant to the exercise of the Option unless and until all of the
following conditions have been satisfied or fulfilled:

               (i)    all waiting periods under the HSR Act and any foreign laws
which are applicable to the issuance of the Option Shares hereunder shall have
expired or been terminated, and all foreign antitrust approvals applicable to
such issuance shall have been obtained and shall be in full force and effect;

               (ii)   all material consents, approvals, orders or authorizations
of, or registrations, declarations or filings with, any Federal, state or local
administrative agency or commission or other Federal, state or local
governmental authority or instrumentality, if any, required in connection with
the issuance of the Option Shares hereunder will have been obtained or made, as
the case may be; and

               (iii)  no preliminary or permanent injunction or other order by
any court of competent jurisdiction prohibiting or otherwise restraining such
issuance will be in effect, and no statute, rule, regulation, executive order,
decree or other order applicable to the Company which has the effect of making
such issuance unlawful shall be in effect.

It is understood and agreed that at any time during which the Option is
exercisable, the parties will use their respective reasonable best efforts to
satisfy all conditions to Closing, so that a Closing may take place as promptly
as practicable.

     4.   Termination of Option.  The Option shall terminate upon the earlier
          ---------------------
to occur of (i) the Effective Time, (ii) twelve (12) full months following the
date on which the Reorganization Agreement is terminated pursuant to Section
7.1(b) or Section 7.1(d) thereof, if no event causing the Termination Fee to
become payable pursuant to Section 7.3(b)(ii) of the Reorganization Agreement
has occurred during such twelve (12) month period, (iii) twelve (12) full months
following the date on which the Reorganization Agreement is terminated pursuant
to Section 7.1(e) thereof, (iv) in the event the Reorganization Agreement has
been terminated pursuant to Section 7.1(b) or Section 7.1(d) thereof and the
Termination Fee became payable

                                      -2-
<PAGE>

pursuant to Section 7.3(b)(ii) thereof, twelve (12) full months following the
payment of the Termination Fee; and (v) the date on which the Reorganization
Agreement is terminated if neither a Triggering Event nor the announcement of an
Acquisition Proposal by a third party occurred on or prior to the date of such
termination; provided, however, that if the Option cannot be exercised by reason
of any applicable governmental order or because the waiting period under the HSR
Act related to the issuance of the Option Shares shall not have expired or been
terminated, then the Option shall not terminate until the tenth (10th) business
day after such impediment to exercise has been removed or has become final and
not subject to appeal.

     5.  Representations, Warranties and Covenants of the Company.  The Company
         --------------------------------------------------------
hereby represents, warrants and covenants to Parent as follows:

          (a)  The Company is a corporation duly organized, validly existing and
in good standing under the laws of the State of Delaware, and has the corporate
power and authority to enter into this Agreement and to carry out its
obligations hereunder.

          (b)  The execution and delivery of this Agreement by the Company, and
the performance by the Company of its obligations hereunder, have been duly
authorized by all necessary corporate action on the part of the Company, and no
other corporate proceedings on the part of the Company are necessary to
authorize this Agreement or any of the transactions contemplated hereby.

          (c)  This Agreement has been duly executed and delivered by the
Company and constitutes a legal, valid and binding obligation of the Company
and, assuming this Agreement constitutes a legal, valid and binding obligation
of Parent, is enforceable against the Company in accordance with its terms,
except as such legality, validity, binding effect and enforceability may be
limited by bankruptcy, insolvency, reorganization, arrangement, moratorium,
fraudulent transfer and other similar laws affecting the rights of creditors
generally, general principles of equity (whether enforcement is sought in a
proceeding in equity or at law).

          (d)  Except for any filings required under the HSR Act and applicable
foreign laws, the Company has taken all necessary corporate and other action to
authorize and reserve for issuance, and to permit the Company to issue upon
exercise of the Option, and at all times from the date hereof until the
termination of the Option will have reserved for issuance, a sufficient number
of unissued Company Shares to enable Parent to exercise the Option in full, and
shall take all necessary corporate or other action to authorize and reserve for
issuance all additional Company Shares or other securities which may be issuable
pursuant to Section 9(a) hereof upon exercise of the Option, all of which, upon
            ------------
their issuance and delivery in accordance with the terms of this Agreement, will
be duly authorized and validly issued, fully paid and nonassessable.

          (e)  Upon delivery of the Company Shares and any other securities to
Parent upon exercise of the Option, Parent will acquire such Company Shares or
other securities free and clear of all claims, liens, charges, encumbrances and
security interests of any kind or nature whatsoever, excluding those imposed by
or in respect of Parent.

                                      -3-
<PAGE>

          (f)  The execution and delivery of this Agreement by the Company do
not, and the performance by the Company of its obligations hereunder will not,
(i) conflict with or violate the Certificate of Incorporation or Bylaws or
equivalent organizational documents of the Company or any of its subsidiaries,
(ii) conflict with or violate any law, rule, regulation, order, judgment or
decree applicable to the Company or any of its subsidiaries or by which its or
any of their respective properties is bound or affected, or (iii) result in any
breach of, or constitute a default (or an event that with notice or lapse of
time or both would become a default) under, or impair the Company's or any of
its subsidiaries' rights or alter the rights or obligations of any third party
under, or give to others any rights of termination, amendment, acceleration or
cancellation of, or result in the creation of a lien or encumbrance on any of
the properties or assets of the Company or any of its subsidiaries pursuant to,
any material note, bond, mortgage, indenture, contract, agreement, lease,
license, permit, franchise or other instrument or obligation to which the
Company or any of its subsidiaries is a party or by which the Company or any of
its subsidiaries or its or any of their respective properties are bound or
affected.

          (g)  The execution and delivery of this Agreement by the Company does
not, and the performance by the Company of its obligations hereunder will not,
require any consent, approval, authorization or permit of, or filing with, or
notification to, any Governmental Entity except pursuant to the HSR Act and any
applicable foreign antitrust laws.

     6.   Parent "Put" Rights.
          -------------------

          (a)  Right to "Put" Option Shares.  At the request of and upon notice
               ----------------------------
by Parent to the Company (the "Put Notice"), at any time prior to the
                               ----------
termination of the Option pursuant to Section 4 hereof (the "Purchase Period"),
                                      ---------              ---------------
the Company (or any successor entity thereof) shall purchase the Option from
Parent, to the extent not previously exercised, at the purchase price set forth
in Section 6(a)(i) hereof (subject to and as limited by Section 6(a)(iii)
   ---------------                                      -----------------
hereof), and the Option Shares, if any, previously acquired by Parent pursuant
to the exercise of the Option, at the price set forth in Section 6(a)(ii) hereof
                                                         ----------------
(subject to and as limited by Section 6(a)(iii) hereof):
                              -----------------

               (i)    The product obtained by multiplying (x) the difference
between (A) the Market/Tender Offer Price (as defined below) for the Company
Shares as of the date Parent delivers a Put Notice, and (B) the Exercise Price,
by (y) the aggregate number of Company Shares that may then be purchased
pursuant to the exercise of the Option, but only if the Market/Tender Offer
Price is greater than the Exercise Price. For all purposes of and under this
Agreement, the term "Market/Tender Offer Price" shall mean the higher of (A) the
                     -------------------------
highest price per share offered as of such date pursuant to any Acquisition
Proposal which was made prior to such date, and (B) the highest closing sale
price of Company Shares then on the Nasdaq National Market during the twenty
(20) consecutive trading days ending on the trading day immediately preceding
such date. For purposes of determining the highest price offered pursuant to any
Acquisition Proposal which involves consideration other than cash, the value of
such consideration shall be equal to the higher of (A) if securities of the same
class of the proponent of such consideration are traded on any national
securities exchange or by any registered securities association, a value based
on the final closing sale price during regular trading hours or the median
between the final bid and asked prices at the close of regular trading hours for
such securities on their principal trading market on such date, and (B) the
value ascribed to such

                                      -4-
<PAGE>

consideration by the proponent of such Acquisition Proposal, or if no such value
     is ascribed, a value determined in good faith by the Board of Directors of
     the Company.

               (ii)   The product obtained by multiplying (x) the sum of (A) the
Exercise Price paid by Parent for Company Shares previously acquired pursuant to
the exercise of the Option, and (B) the difference between (1) the Market/Tender
Offer Price, and (2) such Exercise Price (but only if the Market/Tender Offer
Price is greater than the Exercise Price), by (y) the number of Company Shares
so purchased.

               (iii)  Notwithstanding anything to the contrary set forth in this
Section 6(a), the Company shall not be required to pay Parent, pursuant to the
------------
exercise by Parent of its rights under this Section 6, any amounts in excess of
                                            ---------
(x) $79,000,000, plus (y) the Exercise Price paid by Parent for Company Shares
previously acquired pursuant to the exercise of the Option, minus (z) any
amounts paid to Parent by the Company pursuant to Section 7.3(b) of the
Reorganization Agreement.

          (b)  Payment and Redelivery of Option or Option Shares.  In the event
               -------------------------------------------------
that Parent exercises its rights under Section 6(a) hereof, the Company shall,
                                       ------------
within five (5) business days after Parent delivers a Put Notice to the Company
pursuant to Section 6(a) hereof, pay to Parent the required amount in cash by
            ------------
wire transfer of immediately available funds to an account designated by Parent
in writing, and Parent shall surrender to the Company the Option and the
certificates evidencing the Company Shares previously purchased by Parent
pursuant to the exercise of the Option.

     7.   Registration Rights of Parent.
          -----------------------------

          (a)  Following the termination of the Reorganization Agreement, Parent
may by written notice to the Company (a "Registration Notice") request the
                                         -------------------
Company to register under the Securities Act all or any part of the shares
acquired by Parent pursuant to this Agreement (such shares requested to be
registered being referred to in this Section 7 as "Registrable Securities") in
                                     ---------     ----------------------
order to permit the sale or other disposition of any or all shares of the
Registrable Securities that have been acquired by or are issuable to Parent upon
exercise of the Option in accordance with the intended method of sale or other
disposition stated by Parent, including a "shelf" registration statement under
Rule 415 under the Securities Act (or any successor provision thereto). Parent
shall cause, and shall cause any underwriters of any sale or other disposition
to cause, any sale or other disposition pursuant to such registration statement
to be effected on a widely distributed basis so that, upon consummation thereof,
no purchaser or transferee will own beneficially more than five percent (5%) of
the then-outstanding voting power of the Company. Upon a request by Parent for
registration of Registrable Securities pursuant to the delivery to the Company
of a Registration Notice, the Company shall have the option, exercisable by
written notice to Parent within ten (10) business days after the receipt of such
Registration Notice, to irrevocably agree to purchase all or any part of the
Registrable Securities for cash at a purchase price (the "Option Price") equal
                                                          ------------
to the product obtained by multiplying (x) the number of Registrable Securities
so purchased, by (y) the per share average of the closing sale prices of the
Company's Common Stock on the Nasdaq National Market for the ten (10)
consecutive trading days immediately preceding the date of the Registration
Notice. Any such purchase of Registrable Securities by the Company hereunder
shall take place at a

                                      -5-
<PAGE>

closing to be held at the principle executive offices of the Company or its
counsel at any reasonable date and time designated by the Company in such notice
within ten (10) business days after delivery of such notice. The payment of the
Option Price for the shares to be so purchased shall be made at the time of such
closing by wire transfer in immediately available funds to an account designated
by Parent in writing.

          (b)  If the Company shall not elect to exercise its option to purchase
Registrable Securities pursuant to Section 7(a) hereof with respect to all
                                   ------------
Registrable Securities, the Company shall use commercially reasonable efforts to
effect, as promptly as practicable, the registration under the Securities Act of
the unpurchased Registrable Securities requested to be registered in the
Registration Notice and to keep such registration statement effective for such
period (not in excess of one hundred and twenty (120) calendar days from the day
such registration statement first becomes effective) as may be reasonably
necessary to effect such sale or other disposition; provided, however, that
Parent shall not be entitled to more than an aggregate of three (3) effective
registration statements hereunder. The obligations of the Company to file a
registration statement and to maintain its effectiveness pursuant hereto may be
suspended for up to one hundred and twenty (120) calendar days in the aggregate
if the Board of Directors of the Company shall have determined that the filing
of such registration statement or the maintenance of its effectiveness would
require premature disclosure of material nonpublic information that would
materially and adversely affect the Company or otherwise interfere with or
adversely affect any pending or proposed offering of securities of the Company
or any other material transaction involving the Company. If consummation of the
sale of any Registrable Securities pursuant to a registration hereunder shall
not occur within one hundred and twenty (120) calendar days after the filing
with the SEC of the initial registration statement therefor, the provisions of
this Section 7 shall again be applicable to any proposed registration. The
     ---------
Company shall use commercially reasonable efforts to cause any Registrable
Securities registered pursuant to this Section 7 to be qualified for sale under
                                       ---------
the securities or "blue sky" laws of such jurisdictions as Parent may reasonably
request and to continue such registration or qualification in effect in such
jurisdictions; provided, however, that the Company shall not be required to
qualify to do business in, or to consent to general service of process in, any
jurisdiction by reason of this provision. If the Company shall effect a
registration under the Securities Act of Company Common Stock for its own
account or for any other stockholders of the Company (other than on Form S-4 or
Form S-8, or any successor form thereto), the Company shall allow Parent the
right to participate in such registration by selling its Registrable Securities,
and such participation will not affect the obligation of the Company to effect
the registration of Registrable Securities for Parent pursuant to this Section
                                                                       -------
7; provided however, that, if the managing underwriters of such offering advise
-
the Company in writing that in their opinion the number of shares of Company
Common Stock requested to be included in such registration exceeds the number
which can be sold in such offering, the Company shall include the shares
requested to be included therein by Parent pro rata with the shares intended to
be included therein by the Company.


          (c)  In connection with the registration of any Registrable Securities
pursuant to this Section 7, Parent shall provide the Company with such
                 ---------
information with respect to Parent's Registrable Securities, the plan for
distribution thereof, and such other information with respect to Parent as, in
the reasonable judgment of counsel for the Company, is necessary to enable the
Company to include in a registration statement all facts regarding Parent and
its

                                      -6-
<PAGE>

Registrable Securities required to be disclosed with respect to a registration
of Registrable Securities thereunder.

          (d)  The Company shall pay all fees and expenses incurred in
connection with the registration of Registrable Securities pursuant to this
Section 7, except for underwriting discounts and commissions and the fees and
---------
expenses of counsel to Parent, and the Company shall provide to the underwriters
all such documentation (including certificates, opinions of counsel and
"comfort" letters from auditors) as is customary in connection with underwritten
public offerings and as such underwriters may reasonably require. In connection
with any registration of Registrable Securities pursuant to this Section 7,
                                                                 ---------
Parent and the Company agree to enter into an underwriting agreement reasonably
acceptable to each such party, in form and substance customary for transactions
of this type, with the underwriters participating in such offering.

          (e)  Indemnification.
               ---------------

               (i)  The Company shall indemnify Parent, each of its directors
and officers and each person who controls Parent within the meaning of Section
15 of the Securities Act, and each underwriter of the Company's securities, with
respect to any registration, qualification or compliance which has been effected
pursuant to this Agreement, against all expenses, claims, losses, damages or
liabilities (or actions in respect thereof), including any of the foregoing
incurred in settlement of any litigation, commenced or threatened, arising out
of or based on any untrue statement (or alleged untrue statement) of a material
fact contained in any registration statement, prospectus, offering circular or
other document, or any amendment or supplement thereto, incident to any such
registration, qualification or compliance, or based on any omission (or alleged
omission) to state therein a material fact required to be stated therein or
necessary to make the statements therein, in light of the circumstances in which
they were made, not misleading, or any violation by the Company of any rule or
regulation promulgated under the Securities Act applicable to the Company in
connection with any such registration, qualification or compliance, and the
Company shall reimburse Parent, and each of its directors and officers and each
person who controls Parent within the meaning of Section 15 of the Securities
Act, and each underwriter, for any legal and any other expenses reasonably
incurred in connection with investigating, preparing or defending any such
claim, loss, damage, liability or action; provided, however, that the Company
shall not be liable in any such case under this Section 7(e)(i) to the extent
                                                ---------------
that any such claim, loss, damage, liability or expense arises out of or is
based on any untrue statement or omission, or alleged untrue statement or
omission, made in reliance upon and in conformity with written information
furnished to the Company by Parent, or director, officer or controlling person
of Parent, or any underwriter seeking indemnification from the Company pursuant
to this Section 7(e)(i).
        ---------------

               (ii)   Parent shall indemnify the Company, each of its directors
and officers and each underwriter of the Company's securities covered by such
registration statement and each person who controls the Company within the
meaning of Section 15 of the Securities Act, against all expenses, claims,
losses, damages and liabilities (or actions in respect thereof), including any
of the foregoing incurred in settlement of any litigation, commenced or
threatened, arising out of or based on any untrue statement (or alleged untrue
statement) of a material fact contained in any such registration statement,
prospectus, offering circular or other document, or

                                      -7-
<PAGE>

any amendment or supplement thereto, incident to any such registration,
qualification or compliance, or based on any omission (or alleged omission) to
state therein a material fact required to be stated therein or necessary to make
the statements therein, in light of the circumstances in which they were made,
not misleading, or any violation by Parent of any rule or regulation promulgated
under the Securities Act applicable to Parent in connection with any such
registration, qualification or compliance, and Parent shall reimburse the
Company, and each of the Company's directors, officers, control persons and
underwriters for any legal or any other expenses reasonably incurred in
connection with investigating, preparing or defending any such claim, loss,
damage, liability or action, in each case to the extent, but only to the extent,
that such untrue statement (or alleged untrue statement) or omission (or alleged
omission) is made in such registration statement, prospectus, offering circular
or other document in reliance upon and in conformity with written information
furnished to the Company by Parent for use therein; provided, however, that in
no event will any liability for indemnification under this Section 7(e)(ii)
                                                           ----------------
exceed the net proceeds of the registered offering received by Parent.

               (iii)  Each party entitled to indemnification under this Section
                                                                        -------
7(e) (the "Indemnified Party") shall give written notice to the party required
----       -----------------
to provide indemnification under this Section 7(e) (the "Indemnifying Party")
                                      ------------       ------------------
promptly after such Indemnified Party has obtained actual knowledge of any claim
as to which indemnity may be sought under this Section 7(e), and shall permit
                                               ------------
the Indemnifying Party to assume the defense of any such claim or any litigation
resulting therefrom; provided, however, that counsel for the Indemnifying Party,
who shall conduct the defense of such claim or litigation, shall be approved by
the Indemnified Party (whose approval shall not unreasonably be withheld or
delayed), and the Indemnified Party may participate in such defense at such
party's expense; provided, however, that the Indemnifying Party shall pay such
expense if representation of the Indemnified Party by counsel retained by the
Indemnifying Party would be inappropriate due to actual or potential differing
interests between the Indemnified Party and any other party represented by such
counsel in such proceeding; and provided further, however, that the failure of
any Indemnified Party to give prompt notice as provided herein shall not relieve
the Indemnifying Party of its obligations under this Section 7(e) unless the
                                                     ------------
failure to give such notice is materially prejudicial to an Indemnifying Party's
ability to defend such action. No Indemnifying Party, in the defense of any such
claim or litigation shall, except with the consent of each Indemnified Party,
consent to entry of any judgment or enter into any settlement which does not
include as an unconditional term thereof the giving by the claimant(s) or
plaintiff(s) to such Indemnified Party of a release from all liability in
respect to such claim or litigation. No Indemnifying Party shall be required to
indemnify any Indemnified Party with respect to any settlement entered into
without such Indemnifying Party's prior consent (which will not be unreasonably
withheld or delayed).

     8.  Profit Limitation.
         -----------------

          (a)  Notwithstanding any other provision in this Agreement or the
Reorganization Agreement, in no event shall Parent's Total Profit (as defined
below) exceed $79,000,000 (the "Maximum Profit") and, if Parent's Total Profit
                                --------------
otherwise would exceed the Maximum Profit, Parent, at its sole discretion, shall
either (i) reduce the number of Option Shares subject to the Option, (ii)
deliver to the Company for cancellation Option Shares (or other securities into
which such Option Shares are converted or exchanged) previously purchased by
Parent, (iii) pay cash to the Company or (iv) any combination of the foregoing,
so that Parent's

                                      -8-
<PAGE>

actually realized Total Profit shall not exceed the Maximum Profit after taking
into account the foregoing actions; provided, however, that to the extent the
                                    -----------------
payment by the Company of cash to Parent in satisfaction of the Termination Fee
pursuant to Section 7.3 of the Reorganization Agreement would cause Parent's
Total Profit to exceed the Maximum Profit, then the Company need not pay such
cash portion of the Termination Fee.

          (b)  For purposes of this Agreement, "Total Profit" shall mean: (i)
                                                ------------
the aggregate amount (before taxes) of (A) any excess of (x) the net cash
amounts or fair market value of any property received by Parent pursuant to a
sale of Option Shares over (y) the Parent's aggregate purchase price for such
Option Shares (or other securities), plus (B) any amounts received by Parent
pursuant on the repurchase of the Option by the Company pursuant to Section 6,
plus (C) any termination fee paid in cash by the Company and received by Parent
pursuant to the Reorganization Agreement, minus (ii) the amounts of any cash
previously paid by Parent to the Company pursuant to this Section 8 plus the
value of the Option Shares previously delivered by Parent to the Company for
cancellation pursuant to this Section 8.

          (c)  For purposes of Section 8(a) and clause (ii) of Section 8(b), the
value of any Option Shares delivered by Parent to the Company shall be the
Market/Tender Offer Price of such Option Shares.

     9.   Adjustment Upon Changes in Capitalization; Stockholder Rights Plans.
          -------------------------------------------------------------------

          (a)  In the event of any change in the Company Shares by reason of
stock dividends, stock splits, reverse stock splits, mergers (other than the
Merger), recapitalizations, combinations, exchanges of shares and the like, the
type and number of shares or securities subject to the Option and the Exercise
Price shall be adjusted appropriately, and proper provision shall be made in the
agreements governing such transaction, so that Parent will receive, upon
exercise of the Option, the number and class of shares or other securities or
property that Parent would have received in respect of the Company Shares if the
Option had been exercised immediately prior to such event or the record date
therefor, as applicable.

          (b)  At any time prior to the termination of the Option pursuant to
Section 4 hereof, and at any time after the Option is exercised (in whole or in
---------
part, if at all), the Company shall not adopt (nor permit the adoption of) a
stockholders rights plan that contains provisions for the distribution or
exercise of rights thereunder as a result of Parent or any affiliate or
transferee thereof becoming the beneficial owner of shares of the Company by
virtue of the Option being exercisable or having been exercised (or as a result
of beneficially owning shares issuable in respect of any Option Shares).

     10.  Restrictive Legends.  Each certificate representing Option Shares
          -------------------
issued to Parent hereunder shall include a legend in substantially the following
form:

     THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN
     REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, AND MAY
     BE REOFFERED OR SOLD ONLY IF SO REGISTERED OR IF AN EXEMPTION
     FROM SUCH REGISTRATION IS AVAILABLE. SUCH SECURITIES ARE ALSO
     SUBJECT TO ADDITIONAL

                                      -9-
<PAGE>

     RESTRICTIONS ON TRANSFER AS SET FORTH IN THE STOCK OPTION
     AGREEMENT DATED AS OF SEPTEMBER 18, 2000, A COPY OF WHICH MAY BE
     OBTAINED FROM THE ISSUER.

It is understood and agreed that (i) the reference to restrictions arising under
the Securities Act in the above legend shall be removed by delivery of
substitute certificate(s) without such reference if such Option Shares have been
registered pursuant to the Securities Act, such Option Shares have been sold in
reliance on and in accordance with Rule 144 under the Securities Act or Parent
has delivered to Company a copy of a letter from the staff of the SEC, or an
opinion of counsel in form and substance reasonably satisfactory to the Company
and its counsel, to the effect that such legend is not required for purposes of
the Securities Act, and (ii) the reference to restrictions pursuant to this
Agreement in the above legend will be removed by delivery of substitute
certificate(s) without such reference if the Option Shares evidenced by
certificate(s) containing such reference have been sold or transferred in
compliance with the terms and provisions of this Agreement under circumstances
that do not require the retention of such reference.

     11.  Listing and HSR Filing.  The Company, upon the request of Parent,
          ----------------------
shall promptly file an application to list the Company Shares to be acquired
upon exercise of the Option for quotation on the Nasdaq National Market and
shall use its commercially reasonable best efforts to obtain approval of such
listing as soon as practicable. Promptly after the date hereof, each of the
parties hereto shall promptly file with the Federal Trade Commission and the
Antitrust Division of the United States Department of Justice all required
premerger notification and report forms and other documents and exhibits
required to be filed under the HSR Act to permit the acquisition of the Company
Shares subject to the Option at the earliest possible date.

     12.  Miscellaneous.
          -------------

          (a)  Binding Effect.  This Agreement shall be binding upon and inure
               --------------
to the benefit of the parties hereto and their respective successors and
permitted assigns. Nothing contained in this Agreement, express or implied, is
intended to confer upon any person other than the parties hereto and their
respective successors and permitted assigns any rights or remedies of any nature
whatsoever by reason of this Agreement. Any Company Shares sold in compliance
with the provisions of Section 7 hereof shall, upon consummation of such sale,
                       ---------
be free of the restrictions imposed with respect to such shares by this
Agreement and any transferee of such shares shall not be entitled to the rights
of a party hereto. Certificates representing shares sold in a registered public
offering pursuant to Section 7 hereof shall not be required to bear the legend
                     ---------
set forth in Section 10 hereof.
             ----------

          (b)  Specific Performance.  The parties hereto recognize and agree
               --------------------
that if for any reason any of the terms and provisions of this Agreement are not
performed in accordance with their specific terms or are otherwise breached,
immediate and irreparable harm or injury would be caused for which money damages
would not be an adequate remedy. Accordingly, each party hereto agrees that, in
addition to other remedies, the other party hereto shall be entitled to an
injunction restraining any violation or threatened violation of the terms and
provisions of this Agreement or the right to enforce any of the covenants or
agreements set forth herein by specific performance. In the event that any
action will be brought in equity to enforce

                                      -10-
<PAGE>

the terms and provisions of the Agreement, neither party hereto will allege, and
each party hereto hereby waives the defense, that there is an adequate remedy at
law.

          (c)  Entire Agreement.  This Agreement and the Reorganization
               ----------------
Agreement set forth the entire agreement and understanding of the Company and
Parent with respect to the subject matter hereof, and supersede all other prior
discussions, agreements and understandings between the Company and Parent, both
written and oral, with respect to the subject matter hereof and thereof.

          (d)  Further Assurances.  Each party hereto will execute and deliver
               ------------------
all such further documents and instruments and take all such further action as
may be necessary in order to consummate the transactions contemplated hereby.

          (e)  Validity.  The invalidity or unenforceability of any provision of
               --------
this Agreement will not affect the validity or enforceability of the other
provisions of this Agreement, which will remain in full force and effect. In the
event any Governmental Entity of competent jurisdiction holds any provision of
this Agreement to be null, void or unenforceable, the parties hereto will
negotiate in good faith and will execute and deliver an amendment to this
Agreement in order, as nearly as possible, to effectuate, to the extent
permitted by law, the intent of the parties hereto with respect to such
provision.

          (f)  Notices.  All notices and other communications hereunder will be
               -------
in writing and will be deemed given if delivered personally or by commercial
delivery service, or sent via telecopy (receipt confirmed) to the parties at the
following addresses or telecopy numbers (or at such other address or telecopy
numbers for a party as will be specified by like notice):

          If to Parent, to:

               Sun Microsystems, Inc.
               901 San Antonio Road
               Palo Alto, CA 94303
               Attention:  General Counsel
               Telephone No.:  (650) 960-1300
               Telecopy No.:  (650) 336-0530

          with a copy to:

               Wilson Sonsini Goodrich & Rosati
               Professional Corporation
               650 Page Mill Road
               Palo Alto, California 94304-1050
               Attention: Larry W. Sonsini, Esq.
                          Katharine A. Martin, Esq.
               Telephone: (650) 493-9300
               Telecopy: (650) 493-6811

                                      -11-
<PAGE>

          and to:

               Wilson Sonsini Goodrich & Rosati
               Professional Corporation
               One Market, Spear Street Tower
               Suite 3300
               San Francisco, California  94105
               Attention:  Michael S. Dorf, Esq.
               Telephone:  (415) 947-2000
               Telecopy:  (415) 947-2099

          If to the Company, to:

               Cobalt Networks, Inc.
               555 Ellis Street
               Mountain View, CA 94043
               Attention:  President
               Telephone No.: (650) 623-2500
               Telecopy No.:  (650) 623-2546

          with a copy to:

               Brobeck, Phleger & Harrison LLP
               Two Embarcadero Place
               2200 Geng Road
               Palo Alto, California 94303
               Attention:  Rod J. Howard, Esq.
                           John Montgomery, Esq.
               Telephone No.: (650) 424-0160
               Telecopy No.: (650) 496-2885

          (g)  Governing Law.  This Agreement will be governed by and construed
               -------------
in accordance with the laws of the State of Delaware applicable to agreements
made and to be performed entirely within such State.(h) Expenses. Except as
                                                        --------
otherwise expressly provided herein or in the Reorganization Agreement, all
costs and expenses incurred in connection with the transactions contemplated by
this Agreement will be paid by the party incurring such expenses.

          (h)  Amendments; Waiver.  This Agreement may be amended by the parties
               ------------------
hereto and the terms and conditions hereof may be waived only by an instrument
in writing signed on behalf of each of the parties hereto, or, in the case of a
waiver, by an instrument signed on behalf of the party waiving compliance.

          (i)  Assignment.  Neither of the parties hereto may sell, transfer,
               ----------
assign or otherwise dispose of any of its rights or obligations under this
Agreement or the Option created hereunder to any other person, without the
express written consent of the other party, except that

                                      -12-
<PAGE>

the rights and obligations hereunder will inure to the benefit of and be binding
upon any successor of a party hereto.

          (j)  Counterparts.  This Agreement may be executed in several
               ------------
counterparts, each of which shall be deemed an original, and all of which
together shall constitute one and the same instrument.

                 [Remainder of Page Intentionally Left Blank]

                                      -13-
<PAGE>

     IN WITNESS WHEREOF, the undersigned have caused this Agreement to be
executed by their respective thereunto duly authorized officers as of the date
first written above.

                                    SUN MICROSYSTEMS, INC.

                                    By: /s/ JONATHAN SCHWARTZ
                                       -------------------------------------

                                    Name: __________________________________

                                    Title: _________________________________

                                    COBALT NETWORKS, INC.

                                    By: /s/ STEPHEN W. DEWITT
                                       -------------------------------------

                                    Name: Stephen W. Dewitt
                                          __________________________________

                                    Title: President and CEO
                                           _________________________________


                  * * * * * STOCK OPTION AGREEMENT * * * * *

                                      -14-
</TEXT>
</DOCUMENT>
