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Upside reviews Linux Valuations

Open Season: Filling in the Scorecard
by Sam Williams
October 13, 1999
 
Coming to a business page near you ... the Linus Torvalds Third Millennium High Growth Advantage mutual fund.

OK, so maybe the Linux sector isn't that mature yet. But with last week's initial public offering announcement by Santa Clara-based hardware vendor VA Linux Systems, the so-called "Linux space" is becoming increasingly crowded with public, or soon to be public, companies.

Given investors' general state of cluelessness in regard to the Linux phenomenon, Open Season thought it might be an interesting experiment to ask Linux community members how they separate the wheat from the chaff. Taking our cue from Peter Lynch, the Fidelity fund manager emeritus who perenially advises main street investors to "invest in companies you know," we posed the same question to five individuals with five separate takes on the Linux market: If you were a mutual fund manager putting together a portfolio to track the future development of the Linux sector, how would you divvy up your dollars?

Call it rotisserie fund management.

Needless to say, the answers were illuminating, intriguing and completely useless all at the same time. Investors looking to buy shares in the mythical Linus Torvalds Third Millennium High Growth Advantage would be well advised to read the first advisory in the mythical prospectus: "Never take investment advice from columns written under short deadline."

Having said that, here were the results:

Nathan Myers, president of San Jose-based Linux Laptops, was our first contestant. As an entrepreneur, Myers says he received his first taste of ground-level investors' growing appetite for all things Linux earlier this spring. Following a CNN story on Linux, a caller to the Linux Laptops 1-800 line left a message requesting 50,000 shares in the company.

Since then, Myers says the mania has only increased. In light of this evidence, Myers believes VA Linux Systems, which has already secured the ticker symbol "LNUX," will score an early bounce when Main Street investors finally get a chance to jump onboard.

Conversely, Myers also sees Red Hat (RHAT) struggling to retain its own front-runner status, as the current crop of IPOs inevitably dilute the Linux mystique

"I see Red Hat as the shakiest property," he writes. "They own nothing but the Red Hat brand, and we have already seen Mandrake [a competitive Linux distribution] 'lift' their product and take a substantial fraction of their business away."

As a developer of Debian Linux, a rival to Red Hat's flagship operating system Red Hat 6.0, Myers is understandably biased when it comes to Red Hat's much-acclaimed dominance of the Linux operating system distribution market. (Last week, Debian announced plans with VA Linux Systems, SGI and O'Reilly & Associates to distribute a packaged version of Debian GNU/Linux in retail stores.) As a fictional fund manager, however, Myers views the distribution market as small potatoes.

"Don't neglect the service side," he writes. "It's poised to be much larger than Red Hat's or VA's current business--so much so that VA and Red Hat are both trying to break into it."

While Myers favors pure service-oriented startups such as Linuxcare, he has yet to decide whether young, technologically unencumbered startups hold enough of an advantage to beat large service players such as IBM (IBM). In light of the low barriers to entry within the Linux marketplace, Myers says it will be hard to select a true market bellwether.

"Linux itself will take off exponentially, but the companies that build on it will grow in number more than in size, [competing] on customer satisfaction more than on unique products," he says. "Those that try to lock in their customers will not be seen as Linux companies."

Like Myers, Douglas Bostrom, a senior vice president of research and development at Network Security Technologies Inc., favors a "risk containment" stance for his mythical fund. Unlike Myers, however, Bostrom sees two bellwethers taking the stage within the next 12 months. Dividing his mythical funds between two companies--VA Linux and Linuxcare, Bostrom throws in a "dollop" of IBM "for safety."

"VA and LinuxCare seem to have clearly defined missions and have been in the game long enough to make them leaders in expertise and business savvy," Bostrom writes. "Although I like RedHat, I'm not impressed with their follow-through with regard to being service-centered as opposed to trying to dominate the distribution scene."

A clear fan of traditional software market tactics, Bostrom also faults Red Hat's leading American competitor, Caldera Systems, for similarly "trying to fry too many fish" at one time. When it comes to the software side of his lineup, he saves a pinch-hitting spot for the plucky Brisbane, Calif.-based Pacific Hi Tech.

"For lots of reasons, Linux penetration into the orient seems to be proceeding quite nicely, and TurboLinux seems to dominate that part of the world," writes Bostrom.

Amit D. Chaudhary, a developer who works for an Indian division of the Arlington, Va.-based Entevo, has a slightly sharper view of the Asian continent. Unlike Bostrom, Chaudhary is bullish on Red Hat, earmarking 20 percent of his virtual shares for Red Hat and saving the remaining 20 percent for German-based rival SuSE GmbH or the U.S.-based Slackware, depending on which company makes it to market first.

Chaudhary, however, assigns his biggest individual investment chunk--30 percent--to Linuxcare, citing the company's "high visibility, good investment and distributor independence."

In contrast to both Bostrom and Myers, Chaudhary is bearish on VA Linux Systems. "Hardware has lower obstacles to entry," Chaudhary writes. "Tomorrow, Dell might decide to enter the market and bundle, say Slackware Linux and Linuxcare services."

Christine Peterson, executive director of the Foresight Institute and a woman who holds a distinct footnote in history of open source software for coining the term "open source," steps in to defend VA Linux. Sticking with the Peter Lynch strategy, Peterson delegates a quarter of her virtual portfolio to VA.

"I know Larry Augustin, and he is a very determined and focused guy," writes Peterson. "I also know their CTO, Leonard Zubkoff; [he's] very talented and smart. And they have Eric Raymond on their board, which is useful."

Both Red Hat and Linuxcare earn equal portions of her portfolio, she says. When it comes to delegating the final 25 percent, Peterson scatters it among three companies--Caldera: "I don't know them as well, but I do know that they are focusing on making deals with big companies and on maintaining compatibility. Both pluses in my book"; Andover.net: "I'm not sure they understand the power of what they've got there"; and SGI (SGI) : "They were the first big hardware company to really buy into the open source Linux model."

Peterson says she isn't in a position to invest but admits that emotions might enter into her investment strategy. SGI, a company battered by Wall Street in recent years, deserves more recognition as a Linux company than IBM, if only for its willingness to put so much faith in open source software as a turnaround tool.

"And I like to cheer the underdog," she says.

Less emotional is Bernie Thompson, CEO of CoSource.com, a Redmond, Wash.-based company that attempts to stimulate commercially targeted open source software development by aggregating buyers and allowing programmers to bid for their services. Even after throwing a 10 percent chip his company's way, Thompson still comes up with the most diverse portfolio of the group--nine companies, ranging from Red Hat to Applix.

Thompson puts the most sizable portion of his portfolio on the hardware side, splitting 40 percent equally between VA Linux Systems and Cobalt. "Server appliances with Linux will be an exploding market," says Thompson, referring to Cobalt, a manufacturer of Linux-based appliance servers. Last month, the Mountain View-based company announced its own IPO plans.

As for VA Linux Systems, Thompson says, "There will be a Dell of Linux PCs. VA could be it, if they don't lose focus."

As for software-oriented companies, Thompson's picks range from Red Hat to Applix (APLX), a Westboro, Mass. company that makes Linux-based business software and Web applications. Like Myers, Thompson sees a proliferation of small- and medium-size companies filling the vacuum created by a shrinking Microsoft.

"Companies that do well will do things like build commerce sites, develop strong brands and bundle free software with other products, such as hardware."

No contrived survey would be complete without its shill. For that role, Open Season selected Hadar Pedhazur, a man already building his own real-world open source portfolio as general partner for the Jersey City, N.J.-based Verticality Investment Group LLC.

Although Pedhazur didn't have time to supply numbers prior to press-time, he did side with both the Red Hat and VA Linux bears, at least for the time being.

"I am not sure that any 'specialty' Linux hardware manufacturers will make it big," writes Pedhazur. "As for Red Hat, they could continue to chug along for quite a while. However, the ... money pouring into other distribution vendors, gives me pause to wait until there is a significant pull-back in Red Hat shares."

Despite his aggressive investment activities in the realm of Python, XML and other prominent open source technologies, Pedhazur says he would harbor an overall wait-and-see attitude when it comes to Linux. Until successful application companies can rise out of the Linux marketplace, he sees the sector as all dressed up with no place to go.

"If Linux is really to make it, it will have to have way more 'stuff,'" he writes. "I predict that the things that are missing now, are the things that corporations will pay for."

 


 Linus Torvalds Third Millennium High Growth Advantage Fund
 

Company  Bostrom Chaudhary Myers Peterson Thompson Avg.
VA Linux   40 10 50 25 20   27 
Linuxcare              40 30 15 25 10   24
Red Hat 20 10 25 10   13
IBM 20 10     6
Cobalt 10 20     6
Andover  10 5 5     4
Caldera 15     3
Corel 10     2
CoSource  10     2
Cygnus 10     2
Slackware 10*     2
Sun 10     2
SuSE 10*     2
Applix 5     1
SGI 5     1
TurboLinux 5     1
LinuxOne 0     0

 

* Two-way tie for 20 percent to be decided by first company that reaches IPO.