Why The Markets Still Don't Trust Linux

IT Manager's Journal (OSDN) ^ | Friday May 07, 2004 | Justin Kuepper

[Golden Eagle]

Why The Markets Still Don't Trust Linux

Linux has only recently begun to regain credibility in the financial markets since its speculative debut. However, its licensing model, hefty competition, and lack of maturity still worry investors. Companies such as Red Hat, long past its 1999 speculative highs, are slowly gaining ground while other Linux companies, such as Linspire, are planning initial public offerings. Is Linux finally becoming a viable alternative to proprietary operating systems, or is this rise simply a byproduct of a mini-tech bubble?

The past and present of Linux in the markets

The infamous Linux debut came from Red Hat, which IPO'ed in August 1999 and quickly became one of the hottest stocks of the dot-com era, skyrocketing to more than $151 per share before plummeting to below $7 during the ensuing bust. Then came SCO in March 2000, which opened at $104 per share and has spiraled downward ever since. Perhaps the most extraordinary open source IPO was that of VA Linux Systems (now VA Software, parent of the OSDN) in late 2000. The stock soared almost 500 percent on its first day, peaking at $320 per share, making it the largest single-day gain in IPO history. But again, the stock tanked over time, and now sits at just under $3 per share.

Many other dot-com companies also experienced extraordinary highs due to speculation during this time, however few paralleled these companies. In the end, the business world seemed ready to adopt open-source software, but the financial world wasn't convinced that a stable business plan could be built atop of such a foundation. However, these failures didn't deter more Linux firms from taking their chances going public after the bust.

MandrakeSoft made an attempt to convince the markets of Linux's credibility with its IPO in August 2001 -- the first Linux offering in Europe. After seeing a steady rise, the company eventually ended up filing for protection under Chapter 11 of the federal bankruptcy laws. Despite this setback, however, the stock began trading again on March 8 of this year, has continued to rise, and now sits at around $5 per share from its initial public offering of around $2 per share. Note that MandrakeSoft is also traded on the US OTCBB (Over the Counter bulletin board market). This status alone is signals immaturity; most mutual funds and institutional investors are forbidden to invest in such stocks, leaving it to day-trading speculators to control price movements.

But floating a company is not the only way to gauge the popularity of Linux Software in the financial world – there are also acquisitions. The most recent major acquisition was Novell's purchase of SuSE Linux. This caused an initial surge in Novell's stock from $5 to $7 per share; Novell now sits at around $11 per share. So far, this purchase seems to have been mutually beneficial for both parties. This time, institutions appear to be gaining confidence.

So, what's in store? The newest commercial Linux distribution to arrive on the scene is Linspire (formerly Lindows). This company has been formed and funded by Michael Robertson (former MP3.com CEO). The announcement that Linspire was going to go public came as a surprise to many, considering the company's age and financial condition (not yet profitable).

So, why don't the markets trust Linux/GNU software?

Here are six fundamental reasons:

- These companies are dependent upon external developers (not employed by the companies themselves) to provide them with improvements and to advance the technologies being sold. Any kind of external reliance is frowned upon by investors – especially when it directly affects the main product being sold.

- The core of the main product being sold (the Linux kernel) is maintained by one man, Linus Torvalds, along with a small group of engineers. Again, this kind of control over the heart of the operating system is undesirable in the eyes of investors.

- The success of most of these businesses is dependent on their ability to maintain distribution (and other relationships) with industry-leading hardware manufacturers, distributors, software vendors, and enterprise solution providers. This is somewhat common among software companies; however, since Linux software is not yet proven itself in all genres of the software market, such relationships may be more unstable than those found in traditional software companies.

- Linux companies will cease to be competitive if third-party software developers stop developing solutions compatible with Linux. Some believe that Linux will have trouble attracting industry developers -- especially when they make their move to the desktop.

- There are few technological barriers to entry in the market. Because Linux software is open source, anyone can modify it or easily develop new software that competes with company software. This can all occur with little to no overhead and a lot less time to market than traditional software.

- Finally, legal uncertainty. With not only code in the Linux kernel, but also the very concepts behind GNU licenses under scrutiny, investors remain wary.

But wait -- there is one more thing that scares investors away: the past. Back in the heyday of the dot-com era, speculators pushed technologies stocks to unbelievable highs, where prices could not be justified.

Today, we are experiencing the same thing, except on a smaller scale. While ex-dot-com companies such as Yahoo! have gained the trust of the markets by establishing a solid business plan, companies like Red Hat remain unable to produce enough earnings to justify the price. Right now, Yahoo! trades at a premium of about 146 times earnings, which is somewhat standard for Internet companies. Red Hat, however, trades at a premium of more than 300 times earnings, which is about triple that of Yahoo! and most other Internet companies.

Granted, Red Hat trades significantly lower than where it was in 2000 and has finally attained profitability, but it is still overvalued when compared to its industry. This indicates that investors are showing confidence in open-source technology; however, it remains to be seen whether or not this confidence is well placed. Is the premium worth paying?

So, what does the future look like?

The future looks bright for Linux software. Overall, there is a gain in market share across the board (from servers to desktops) as businesses are beginning to see the value of migrating to this software. As more and more businesses migrate, a lot of the fears regarding third-party software and support will be resolved. Also, the legal disputes initiated by the SCO Group seem to be progressing and will most likely come to a close later this year; this will put an end to a lot of investor fears.

Despite the positive outlook for Linux software in general, companies that sell this software may not experience such growth. Many of the reasons that investors worry are difficult to resolve. The GNU license itself inherently causes the open-source market to have low barriers to entry. Furthermore, Linus Torvalds and a small team of engineers will always be developing the Linux kernel, so there will always be a reliance on others.

In the face of these setbacks, Linux software vendors are pioneering new ways to profit. Linspire, for example, has introduced a subscription service, which gives users access to a Click-n-Run warehouse, OS updates, and more. Red Hat and other more traditional vendors have been expanding their subscription-based support services to help increase their revenue. Linspire and Mandrake have also had their operating systems pre-installed on WalMart PCs being sold at extremely cheap prices. Linux/GNU software companies are banking on these innovative new methods of increasing revenue to offset the risks that they their businesses may incur in the future. So far, investors are optimistic.

[Golden Eagle]

Now before you Linux advocates go screaming bloody murder, you might notice the parent website of the article is OSDN, an open source group who also host Linux.com.

The author makes some very good points, but also leaves out other significant reasons US investors are leary of Linux, such as the anti-capitalistic goals of the Free Software Foundation, who wrote the Linux license and publicly proclaim on their website their "ultimate goal" is the "end of proprietary software". Their leader Richard Stallman is a flaming anti-American, who on his own personal website www.stallman.org actively cheers on the Iraqi's in the on-going war in Iraq, something most Americans aren't too hip about once they found out. Even the worldwide Linux "community" is of questionable moral standing, cheerleading the mydoom virus attacks against US software company SCO (who are claiming in US Federal Court Linux is an illegal duplicate of Unix) and possibly even being behind the creation of the virus itself.

Bottom line, there's a suspicious dark cloud over Linux, and not 1 single bright success story despite years and years of hype.

[Golden Eagle]

Have at it.

[ColoradoSlim]

Could it be peoples latent and deep seated fear and total abhorrence of penguins?

[taxcontrol]

Interesting in it's absence from this article is the support that IBM and HP have been providing to Linux.

[Golden Eagle]

Could it be peoples latent and deep seated fear and total abhorrence of penguins?

You know, I really don't think so. IMO the pengiun seems to help Linux acceptance, and distract from the actual issues. I've even heard that during Linux deployments some system admins even give out soft cudly suffed-animal versions to help users going through the shock of losing their beloved Windows software and related applications. Wouldn't work with me, though, I don't really care for stuffed animals myself.

[eno_]

If Red Hat has a P/E ratio (which is hard to critique without a revenue number and market cap number) 3X of Yahoo, I'd say that "market" has an irrationally large amount of confidence in Linux.

[chilepepper]

One of the main reasons the Markets still don't trust Linux is because Microsoft spends a great deal of money convincing them not to (vis their funding of SCO in order to sow Fear, Uncertainty and Doubt -- FUD for short).

Microsoft's problem is that the folks who gave them their start in the business, e.g.- IBM, who also happen to be the company that INVENTED FUD as a marketing ploy, has turned against them. IBM is the Linux champion and white knight.

In a matchup between IBM and Microsoft, do you seriously believe that Microsoft will win that battle?

Linux Rules!

[Golden Eagle]

In a matchup between IBM and Microsoft, do you seriously believe that Microsoft will win that battle?

LOL, still relying on OS/2 to run your business I see.

[blackfarm]

I'm using Linux right now. Linspire is a awesome company that has an awesome product.

http://www.linspire.com/

[Michael Barnes]

There's other solid offerings out there..

[isthisnickcool]

Is Linux finally becoming a viable alternative to proprietary operating systems, or is this rise simply a byproduct of a mini-tech bubble?

This is a dumb question. The answer to ths dumb question has been "yes" for several years.

[Doug Loss]

Bottom line, there's a suspicious dark cloud over Linux, and not 1 single bright success story despite years and years of hype.

You clearly haven't been reading the multitudes of bright success stories all over the tech press. One thing to note here is that the markets "trust" anything they perceive as being able to generate a reliable profit. They don't "trust" Linux because they don't see how it can do that. What you misunderstand (don't feel bad; lots of people do) is that Linux and Open Source software in general have the effect of shrinking the market in the areas where they are increasingly accepted. Therefore, the markets aren't fond of them. After all, if someone is giving away something as good as or better than what you're selling, where is the incentive for anyone to buy from you? I think a better measure of Linux and Open Source software's acceptance will be the success of the companies that are moving to it whole-heartedly (IBM and Novell come to mind immediately).

[Bush2000]

In order to inspire investors, you need to have some kind of advantage that your competitors don't have. For example, a proprietary formula (i.e. Coca-Cola), information (i.e. Google), or product (i.e. Porsche, BMW, etc). Linux companies simply don't have much differentiation between them. That's why Red Hat and many other Linux vendors have turned hard-right, away from Stallman to embrace Enterprise service level agreements. Free Linux is worth zero. Over time, it is the commercialization (and, hence proprietization) of Linux that will increasingly lend confidence to investors. Red Hat and IBM are arguably in the best position to leverage this wave. What these companies really offer are high-dollar services atop Linux. Only continued investment in proprietizing their offerings will build market confidence.

[Sam the Sham]

Could it be said that the key reason for IBM support of Linux is that it will serve as a big iron operating system ? There are applications for which big iron and only big iron will do and it is impossible to persuade anyone under the age of 30 to learn COBOL, MVS, JCL, etc ?

[Golden Eagle]

There's no shining star for Linux right now. Novell's move is considered by many to be one of desperation, since their other products were withering on the vine a la Banyan. IBM has lost battles to market leader Microsoft as well, and they are now joining forces and appealing to a worldwide audience with Linux. They've won a few battles, like the city of Munich Germany, but total $ income from worldwide sales of operating system software is still dominated by Windows and Unix.

IBM sells those products too, en masse, so they are well diversified, whereas Novell and Red Hat aren't. Those two companies are here to stay, but their ability to grow into powerhouses is crippled due to the fragmentation of Linux whereby they are competing for the same customers who together still only represent a minority of the market. I expect Linux to continue to creep into the overall *nix market share, but ultimately only further fragmenting it and limiting growth.

[Golden Eagle]

Linux companies simply don't have much differentiation between them. That's why Red Hat and many other Linux vendors have turned hard-right, away from Stallman to embrace Enterprise service level agreements. Free Linux is worth zero. Over time, it is the commercialization (and, hence proprietization) of Linux that will increasingly lend confidence to investors.

Spot on, there's not much differetiation because they have to give many improvements they make to their own version of Linux back to "the community", thereby immediately allowing their competitors to implement those features into seperate competing versions. This only further fragments the market, something discouraging to investors as they realize it is too much competition for the amount of demand which will keep prices at extremely low levels.

As you infer there will be increased "commercialization" of Linux, including attempts to legitimize it's legal standing via cross-patent agreements between companies like Sun, Microsoft and Novell. Once this "rite of passage" has been granted, and the leading commercial versions of Linux began to implement more proprietary components atop their distros, we'll see those versions, not necessarily all versions, become better targets for investment. Still a ways off, IMO. There's going to be a civil war within "the community" first.

[Penner]

Right now, Yahoo! trades at a premium of about 146 times earnings, which is somewhat standard for Internet companies.

They won't trust Linux, but they'll trust this extremely overvalued company, LOL.

Penguins rule!

[Cicero]

Makes sense to me. For a large corporation to invest in Linux means training its IT staff to deal with it but, more important, training all its workers to use it. Most people have some experience with Windows computers. Few have experience with Linux.

So it would take a very substantial amount of time and money to go over to Linux. It would make no sense unless you knew that Linux will continue to be developed at a rate similar to Apple and Microsoft and the concurrent development of memory chips and hardware. What if you went through this huge conversion effort and, a few years later, Linux started to die on the vine?

The history of open-source software has not been great. Look at Java. It started out brilliantly, but the beta development was very ragged and improvements came more and more slowly. And look at the poor relations between Sun and the open software community. You have to have someone in charge, such as Sun or Red Hat, but that begins to offend the open source folks and they may decide to go off en masse and do something more interesting.

Microsoft, on the other hand, has a track record. It will be here the day after tomorrow.

[Golden Eagle]

They won't trust Linux, but they'll trust this extremely overvalued company.

I guess we all have our opinions. Yahoo is the best application on the internet, as has been for years, as far as I'm concerned. I use it as my startup page, as a matter of fact.

[ChadGore]

blah wubba tadda blah wubba blah . . , but it's free !