A Second Look at Linux
With innovative programming, more receptive corporate customers, and a new Intel chip, open-source stocks may be a bargain
Sam Jaffe writes about the markets for Business Week Online
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In February I cautioned investors to be wary of the high stock prices of Linux-related companies Red Hat (RHAT) and VA Linux (LNUX). Well, the slide in the Nasdaq has taken care of that. Since February, the two companies are down an average of 71%. The two other private companies I mentioned, TurboLinux and LinuxCare, both delayed their planned initial public offerings as investor enthusiasm for the sector dried up.
But now that Linux stocks are affordable again, it's time to reassess the Linux market as a whole. To the uninitiated, Linux is a computer operating system that competes with the various forms of Unix and Windows 2000 (the two most commonly used operating systems). Unlike its competitors, Linux' underlying source code is open for anyone to view it and make changes -- as long as those changes are published and available to all. The software itself is free, in monetary terms and in intellectual-property terms, although companies that produce it can and do charge for technical support and services.
Linux was practically unknown for the first seven years of its life until the media discovered it in 1998. Then it was hailed as the cure-all for every computer woe. This hubbub has finally died down.
That's good news for those with money to invest. Even as the Linux stocks reenter the atmosphere, prospects for the operating system are blasting off. More than a third of all Web servers use Linux, according to software-monitoring firm Netcraft. Every major computing company, with the exception of Microsoft (MSFT), has embraced Linux and launched initiatives to provide Linux-related products. At the vanguard of the movement is IBM (IBM), which now produces servers, laptops, and mainframes that run on Linux.
"LINUX HAS ARRIVED." One of the last holdouts, Hewlett-Packard (HWP), announced on Aug. 14 that it had adopted Linux as a strategic operating system. "Linux has arrived," says Jim Bell, director of HP's Open Source and Linux Operations. "Customers have been asking us to offer our products in the Linux environment, and we've complied."
Even Raleigh-based Red Hat, long-derided for trying to make a business out of a free software, has had a good six months. The company recently announced that it has teamed with cell-phone maker Ericsson (ERICY) to design and produce a new generation of wireless Internet devices that will run on Linux. Indeed, much of Red Hat's focus has turned to the embedded market, those small single-use devices that have Linux embedded onto their chips. Analysts expect the company to lose 7 cents per share this fiscal year and earn 4 cents per share next year.
Meanwhile, TurboLinux and LinuxCare are both going full steam ahead, despite the postponement of their IPOs. TurboLinux recently released a new version of its software that is optimized for Oracle's (ORCL) 8i database product, one of the most popular pieces of business software. LinuxCare has teamed up with several hardware vendors, including Hewlett-Packard and Sun Microsystems (SUNW) to provide certification systems and technical support. Both companies have recently successfully completed new rounds of private financing.
SOARING REVENUES. While most of the attention has been paid to using Linux for servers or for smaller Internet devices, significant advances have been made on the desktop, a region of computing currently monopolized by Microsoft. Although Linux has made little headway in terms of market share, it has matured considerably as a desktop alternative. Caldera Systems (CALD) and Corel (CORL) both have produced easy-to-install versions of Linux for those who wish to install it themselves.
At the same time, a consortium of heavy hitters, including Sun, IBM, and Compaq has joined with the GNOME Foundation -- the main cheerleader for a new desktop interface that has won rave reviews. The consortium's plan is to complete a new desktop interface for Linux, including an open-sourced suite of office-productivity software, by the end of the year. The most exciting news, though, comes from VA Linux. Although the company's stock price has struggled the past six months, its revenue growth hasn't slowed at all. In the company's fiscal fourth quarter, which ended in July, sales increased 470% over 1999's fourth quarter. Based on 2001 estimates, the company sells at a price-to-revenue ratio of 4.9. Competitors Sun Microsystems and Dell (DELL) have traded in the past year in a range as high as 8.7 "even though LNUX is expected to grow continually faster," says Deutsche Bank Alex. Brown analyst Phil Rueppel, who recently upgraded the stock to a 'strong buy' recommendation.
VA Linux' core business of selling servers optimized for the Linux operating system got a big boost when company programmers developed a new build-to-order-software system (called BOSS). The Web-based service allows customers to input their exact needs and then places only the necessary software on each computer. The entire process is entirely automated. "This extends Michael Dell's vision of build-to-order hardware into the realm of software," says CEO Larry Augustin. "This is a truly revolutionary product, and it gives us a huge competitive edge."
A NEW CHIP. Independent analysts agree with Augustin's enthusiastic assessment. The reason why the new BOSS system will be popular is because information-technology departments had previously spent hours loading specialized software onto each new machine they bought, one of the biggest time-wasters in every IT employee's workday. "This solves a huge problem," says Stacey Quandt, an analyst with the Giga Information Group. "It allows a company to optimize its hardware with exactly the software they need."
George Weiss, an analyst with Gartner, goes even further. "As the program develops, it will allow VA Linux to become a vendor of software, also. Independent software vendors will pander to them to be listed on the system. It's a very clever way of utilizing all the best things that free software and the open-source community have to offer," says Weiss.
The big event that everyone in the Linux community is awaiting is the release of the IA-64 chip by Intel, soon to be renamed the Itanium. That chip is the first new-generation chip since the introduction of the Pentium in 1994. The new chip promises enormously faster speeds and a giant leap in memory over even the most advanced Pentium 4. As in every previous semiconductor cycle, the entire computing industry will slow down and then ramp up again as the Itanium hits the market.
The difference this time is that Microsoft isn't the only company to get advanced plans of the new chip. Intel also has been sharing its blueprints with most of the main Linux developers and has even taken an equity stake in some of them. The first application of most Itanium computers will be as servers, which is Linux' main competency. Augustin, VA Linux' CEO, points out that Linux has a big head start in working on the Itanium because it has already been tweaked to perform well on similar types of chips that are already available, such as Sun's Sparc and Compaq's Alpha. Windows was never designed to run on those chips.
The leap to Itanium, which is Intel's first 64-bit chip, will be a much more natural one for Linux than it will be for Windows 2000, which was designed for older versions of Intel's chips. "When the IA-64 comes out, the entire slate will be wiped clean," says Augustin. "Linux will really shine in that environment."
There are plenty of roadblocks in the path of that vision becoming reality. Lots of corporate buyers who don't like to try anything new still have to be convinced of Linux' durability. And Microsoft is still in the early stages of its launch of Windows 2000, which will only become a better competitor as time goes by. But if Augustin is right, then his stock, along with other Linux stocks, looks pretty cheap right now. |
