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Take shelter in the next wave of Linux plays
by J.K. Riggin
We can disagree about business models, but the growth of the Internet is undeniable. Content, carriage and commerce have ridden the wave that has given America Online (AOL:NYSE) stunning clout, PSINet (PSIX:NASDAQ) room to breathe and nine lives for Amazon.com (AMZN:NASDAQ).
Still, the Internet-fueled market for software has not been so dramatic for a variety of reasons. E-commerce, advertising and content management requirements are highly customized. Software development cycles are typically much longer than Web deployment cycles. And most significantly, Microsoft (MSFT:NASDAQ) has had a lock on desktop computer operating systems and applications (as a result, its stock has more than quadrupled in value over the past three years).
But then came Linux and the open source movement. And as the operating system has been rapidly growing in popularity with programmers, the corporate world has remained hooked on Microsoft software. Yet now, as companies struggle through their "e-business" strategies, Linux has quickly become an attractive, scalable and free option compared to the Wintel standard.
The real impact of Linux as a viable open source alternative is rapidly becoming apparent. In February — two weeks ahead of Microsoft's release of its long-awaited Windows 2000 operating system upgrade for the enterprise market — a consortium of corporate IT blue chips (including Intel, IBM, and Hewlett-Packard) announced they were backing the latest release of Linux that will run on Intel's new 64-bit Itanium processor. This is perhaps the latest and greatest step up in momentum for Linux as a serious choice in the fast-growing high-end server space now dominated by Microsoft and Sun Microsystems (SUNW:NASDAQ).
Giving it away
In the early 1970s, the legendary Bell Labs created the first versions of the Unix server operating system. Linux is not Unix, but it looks like Unix and has many of the same features and benefits (it's fast, portable, scalable and almost infinitely adaptable to users' needs).
To best support and service the software, these versions of Unix were copyrighted and licensed by their publishers, thereby limiting outside developers' ability to continue to refine and enhance the software. In the mid-1980s Richard Stallman began developing an open source version of Unix called GNU (which stood for GNU is Not Unix) and published the "GNU Manifesto" and "GNU General Public License," which laid the ground rules for open source software being free and available.
An open source operating system is not so much a product as much as it is a public resource. And in the late 1980s and early 1990s, these open source alternatives were not as reliable and did not offer the same level of support as their copyrighted, licensed ("closed") alternatives.
But then along came Finnish computer science student Linus Torvalds. In the early 1990s, he sought to bridge the gap between the vast opportunities of open source software and the usability requirements of the rest of the world. Torvalds' efforts were blessed by the explosion in Internet use, as hundred of thousand of developers from around the world contributed to the freely available Linux. These developers included companies such as Red Hat (RHAT:NASDAQ) and Caldera, which began to create and support distributions of Linux bundled with business applications and a graphical interface.
Turning a philosophy into profits
By April, 1999, Linux ran on 31% of the Internet's Web servers, more than any other operating system. In the second half of last year, three Linux service providing companies went public and exposed the market to the potential of Linux. All three went through the roof. Red Hat provides Linux software, service and support. Andover.net is a Web portal dedicated to Linux content. VA Linux (LNUX:NASDAQ) provides computer hardware ready to run Linux. And just this past month, VA Linux Systems bought Andover.Net for approximately US$800 million.
The Linux space today resembles the early ISP business models of 1995 — with more upside. Early ISPs were delivering access to the public network, which itself was very nearly free by virtue of early peering agreements between backbone providers. Customers pay for service and support.
Because of the overhead required to build out, manage and maintain a network capable of supporting rapid growth, most ISPs have merged with telephone companies. The most notable exceptions are PSINet, which is still losing money; Earthlink (ELNKD:NASDAQ), which is in the midst of a race to acquire customers through other ISPs to survive; and AOL, which has successfully incorporated content and commerce revenue into its business model.
The Linux opportunity is almost entirely in services and support, if not also content and commerce to a lesser degree. The operating system is available for free, but if you want it to work for your company, you need the value adds of custom development and long-term support (both of which you still pay for in the world of copyright, licensed software).
This year's beauty contest
Sequels to blockbusters do well on Wall Street, and the Linux moonshots of 1999 were just the opening credits. Following are two of the hotter upcoming Linux IPOs, and another to avoid.
Caldera Systems (symbol to be CALD on the NASDAQ filed its S-1 on Jan. 10. The company recently raised US$30 million in private equity financing from Sun Microsystems, Citrix, and Novell, among others. Besides being one of the more experienced providers of Linux solutions, Caldera offers a wide range of mature 32-bit software applications for corporate Internet, intranet, network and desktop needs.
Beyond its software products, the upside with Caldera is in its training centers (a high-margin offering) and its network of more than 750 value added resellers — the first in the Linux market space.
Linuxcare (symbol to be LXCR on the NASDAQ) filed its IPO registration statement on Jan. 19. The company provides technical support for Linux users and offers international reach and deep expertise. Linuxcare is trying to become the one-stop shopping destination for all Linux-related technical support services, such as telephone-based customer service, systems consultation and customized installations.
The upside for Linuxcare is its ability to plug into established vendors to handle Linux support on an outsourced basis. The company already has relationships with Dell Computer, Hewlett-Packard, IBM Global Services, Motorola, NEC Software, Oracle, Sun Microsystems and TurboLinux. The kicker is the company's veritable Who's Who list of investors, which includes the king-maker venture capital firm Kleiner Perkins Caufield & Byers, not to mention funding from Dell, Sun Microsystems, Oracle, and Motorola. Yes, this one's a keeper.
Remember the iVillage (IVIL:NASDAQ) IPO about this time last year? The female-oriented Web site popped a virile IPO, but went limp in the aftermarket. The same red flags are waving around Linuxone (symbol to be LINX on the Nasdaq), which submitted its S-1 last September. The company has been in business for less than a year and has no revenue. All it really has are some nifty products (a hard drive pre-loaded with Linux and a program than handles Macintosh media on a Linux system) and the right name at the right time. Given the Internet investing world, this might be enough to pass muster with the SEC.
More likely, the company will get bought before an IPO. If Linuxone does make it to the party, stay away. Too many investors have been burned on Internet IPOs to fall for an issue simply having the word "Linux" in it's name.
Don't forget the first-movers
Though RedHat and VA Linux have fallen way back from their stratospheric IPO levels, both are solid companies. Should the market cap of Red Hat fall beneath the US$5 billion range, or that of VA Linux dip beneath US$1 billion, jump on either one. Either company would be a peach of an acquisition for one of the blue chip IT services big boys.
eOn Communications (EONC:NASDAQ) recently went public to relatively little fanfare. The company develops Linux servers and is focused on delivering integrated voice, e-mail and Internet communications solutions for customer contact centers (i.e., everything from 911 calls to customer service centers to telemarketing facilities).
Though the company has not posted explosive quarter-to-quarter growth, it is profitable. Against a backdrop of growing Linux excitement, this stock is cheap at under US$25.
There also are bargains available among companies that are not purely dedicated to Linux. The world beyond Microsoft is littered with bastard step-children software companies.
Like Applix (APLX:NASDAQ), developers of a range of business applications, including customer relationship management and business intelligence tools. Although the company has historically worked in both the Windows and Unix environments, they are moving rapidly toward Linux. It gets better, too. Not only is the company profitable, but it's already serving more than 3,000 customers worldwide, nearly three-fourths of the Fortune 50 and more than half of the Fortune 500.
At less than US$20 a share and a US$175 million market cap, with a solid Linux game plan intact, Applix is waiting to be discovered.
Finally, there's Corel (CORL:NASDAQ), developer of the famous drawing software and then purchaser of WordPerfect. After a trainwreck 1998 (with stock dipping south of US$5) and rebuilding 1999, Corel made waves in December with several announcements to port its applications to Linux. Then last month the company announced it would acquire Linux developer Inprise/Borland (INPR:NASDAQ) and the market yawned. At issue is Corel CEO Mike Cowpland's ability to execute, or, rather, his track record of over-promising and under-delivering.
Depending on how you look at it, Corel is a US$1 billion company that is either a victim of the Microsoft juggernaut or its own mistakes. Credit Cowpland for jumping on Linux early and having the balls to pull on the Inprise deal in short order. The pieces are all there for Corel to move on to a US$10 billion valuation enjoyed by Red Hat, if Corel can become the flavor-of-the-month. And boards have a way of jettisoning CEOs who repeatedly fail to deliver. At a current price under US$20, it's time for Corel to take off.
Conclusion
In his 1985 "GNU Manifesto" Stallman wrote, "Once GNU is written, everyone will be able to obtain good system software free, just like air. This means much more than just saving everyone the price of a Unix license. It means that much wasteful duplication of system programming effort will be avoided. This effort can go instead into advancing the state of the art."
At the time it had little impact. Few people had access to the Internet and most network administrators favored the safety of a license. Now, between the arrival of Linux, the Internet and more capital than ever before, the state of the art Stallman envisioned is about to hit warp speed.
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