nytimes.com
Why Few Funds Are Lining Up to Buy
Linux
By DANNY HAKIM
Remember Linus
Torvalds? Last year, the
Linux operating system he
created was going to
revolutionize the software
industry, do more damage to
Microsoft than the Justice
Department and make investors
rich. This year, Linux stocks
have been in a prolonged
downward spiral, and Mr.
Torvalds has been replaced as
a media favorite by Napster's
founder, Shawn Fanning, the
latest technologist viewed as
most likely to wreak havoc on
traditional businesses.
Individual investors might see
the depressed stock prices of
the companies that sell services
and products supporting the
free Linux operating system as
a buying opportunity. Last
week, the stocks even showed
signs of recovery after a Linux
conference in San Jose, Calif.
But a key problem remains:
Wall Street is not buying the
Linux pitch. Professional money
managers have done little
beyond pocketing quick gains
after the gold rush last year of
initial public offerings.
That presents two caution flags
for the average investor: What is holding Wall Street back, and how far
can Linux companies go without institutional support?
Consider VA Linux Systems. Last December, this Silicon Valley
company, which makes and supports Linux-equipped servers, gained
almost 700 percent on its first day of trading, the biggest gain ever for a
public offering.
But only 24 out of several thousand mutual funds now hold the stock,
according to Morningstar Inc., while 35 hold Red Hat, the North
Carolina company that sells Linux-related applications.
For two companies that are considered leading lights among the Linux
stocks -- which also include Caldera Systems, Corel and Cobalt
Networks -- this is scant endorsement.
By comparison, some of last year's other hot initial public offerings have
received a far warmer reception. Ariba, the Internet software company,
has 158 fund holders. Phone.com, which makes software for cellular
phones, has 132, while Brocade Communications, which makes the
switches used in computer networks, has 213.
Why the lack of interest in Linux?
"We're kind of indifferent at this point," said Andrew S. Cupps, manager
of the $857 million Strong Enterprise fund. "We've looked at Red Hat
and VA Linux, but we've decided to watch for a while."
From the standpoint of technology, Mr. Cupps is intrigued by Linux. But
he and other professional investors question how much money companies
can make selling services and products around a free operating system.
Even though VA Linux's stock has fallen 80.8 percent this year, and Red
Hat's by 77.8 percent, Mr. Cupps is concerned that valuations are still
high.
So are his colleagues at Strong Capital in Chicago. Last year, Ronald
Ognar and Derek Felske bought 3,500 shares of VA Linux for their
Strong Mid-Cap Growth fund. They have since sold their shares.
"By definition, nobody owns the code, so nobody can sell it," Mr. Cupps
said. "They have to be creative and find other ways to drive revenue. The
way each company does that is through services. The irony is they're
being valued like software companies, but their revenue models are going
to be more like technology consultants."
John Hurley, a money manager at Bowman
Capital, a $5.5 billion Silicon Valley
investment firm, said, "I'm not sure how this
becomes a big, profitable business."
To date, Linux has made its strongest
impact in the market for servers, the
powerful computers that drive technology
networks. But Mr. Hurley said he believes
that the chiefs of technology departments at
many large companies are hesitant to take a
chance on Linux.
"You don't get paid to be a hero," Mr.
Hurley said. "You get paid to make sure
that things don't break, and when they do
break, you can fix them instantly."
Bowman had a position in Red Hat at the
end of June, according to a Securities and
Exchange Commission filing. But it now has
no positions in public Linux companies.
Eric Gerster, a technology analyst for T.
Rowe Price, agreed with Mr. Hurley.
"A lot of Linux momentum was
dot-com-driven last year -- companies putting in Linux to start their Web
operations because it was inexpensive," Mr. Gerster said. "But as they
became real businesses and wanted more support, they either bought
Sun servers or a Windows NT server."
Technology investors do agree that Linux, with its open source code, has
tapped into a deep well of desire among young software developers, but
convincing Wall Street will be more difficult.
VA Linux, in its quarter ended April 28, had $34.6 million in revenue, up
71 percent from the previous quarter and 710 percent from the
comparable period a year earlier, but still lost 23 cents a share. The brisk
revenue growth has not been enough to convince more than a couple
dozen fund managers that the company is worth a $1.7 billion market
capitalization.
"They're trying to figure out our business and our business models," said
Larry Augustin, founder and chief executive of VA Linux. "It's mostly a
matter of time, where people show consistent results."
VA is priced at about 22 times its last 12 months of revenue, cheap
compared with Red Hat's price-to-sales ratio of 78.3, but well in front of
Dell, which is priced at about three times its revenue.
"Is Linux for real? Yes," said Mr. Gerster of T. Rowe Price. "Will it
generate enough revenue to justify the market caps? I don't think so, and
that's why people aren't investing." |
