Open Source Open Season

The big IBM-Sun news has come and gone; so far with­out an out­come.  It’s going to be ugly for Sun.  A sit­u­a­tion like this is absolutely fatal to an orga­ni­za­tion.  The wheels of employee defec­tion and revised cus­tomer spend­ing plans are set in motion and there is lit­tle that can be done to stop them.  Sun senior man­age­ment and the board prob­a­bly have no idea how much has already hap­pened in the last two weeks.  So whether they under­stand the urgency to find a solu­tion for share­hold­ers is an open question.

Right after the IBM-Sun deal fell through the spec­u­la­tion turned to Red Hat.  The rea­son is that we are in a per­fect time for open source com­pa­nies and solu­tions.  Bud­gets and spend­ing are under huge pres­sure and all the growth seems to be at lower price points.  The net­book craze is a good exam­ple of this.  There are designs out there that promise for­mi­da­ble per­for­mance with HD video and high end graph­ics at “stu­pidly cheap prices” accord­ing to eager cus­tomers.   This has become a motif in many areas of tech­nol­ogy adop­tion and growth.

What is very valu­able in this mar­ket at Sun is the MySQL data­base which has become the stan­dard for many web-based appli­ca­tions.  Java has also become the stan­dard for most dis­trib­uted enter­prise appli­ca­tions.  Finally the OpenOf­fice pro­duc­tiv­ity tools have been a dis­ap­point­ment so far in terms of mar­ket pen­e­tra­tion but in the hands of IBM they could cer­tainly do some more dam­age to fran­chises like Microsoft Office.  (Google and Apple are nip­ping away there already.) At $6.56 Sun has a mar­ket cap of $6.3B but a TEV of $4.9B.  At a TEV/Revenue of 0.4x the com­pany seems hard to resist.  Our guess was that IBM had room to sweeten their offer to do the Sun deal but we were wrong.  (Per­haps not sur­pris­ingly since we skipped our reg­u­lar golf game with Sam Palmisano last weekend.)

It’s not Linux itself that is inter­est­ing but these open source prod­ucts on top of it that can deliver quite a bit of busi­ness value at very low cost.  Red Hat pur­chased JBoss which was a very hot open source appli­ca­tion server in the past and could be use­ful.  IBM already has a full suite of mid­dle­ware so our guess would be that a Red Hat solu­tion would be aimed more at the SMB mar­ket to drive money away from the pock­ets of Microsoft than being used to drive deeper into enter­prise soft­ware infra­struc­ture.    You never know though.  Red Hat has been try­ing to add fea­tures on the OS to bring about vir­tu­al­iza­tion and man­age­ment capa­bil­i­ties.    As of yet their efforts haven’t made much of a rip­ple in the enter­prise mar­ket but again in the hands of IBM, maybe they could be more cred­i­ble.  (Right now VMware con­tin­ues to be a clear #1 with no viable #2.)  Red Hat is trad­ing with mar­ket cap of $3.6B and a TEV of $2.9B or about 4.4x revenues.

Cit­rix pur­chased open source vir­tu­al­iza­tion com­pany Xen some time ago for about $500M.  Like Red Hat they haven’t gained much ground on VMW but are incor­po­rat­ing it into some of their own appli­ca­tion and desk­top vir­tu­al­iza­tion solu­tions.  The issue often is ser­vice and sup­port if a #2 to VMW is going to be con­sid­ered.  In most cases it’s not worth the risk.  (The Microsoft solu­tion will be used in Microsoft envi­ron­ments but that’s another story.)  Cit­rix does have one other aspect that IBM might like uniquely.  They have the #2 posi­tion behind WebEx for online meet­ings. IBM has their own ser­vice that is part of Lotus but it’s a dis­tant run­ner in the race. Now that Cisco is tweak­ing IBM in the server space it might be fun to do some of it back with the Cit­rix GoToMeet­ing fam­ily of prod­ucts.  Cit­rix has a mar­ket cap of $4.5B but a TEV of $3.8B or about 2.4x total revenue.

Scrap­ing the bot­tom of the bar­rel is Nov­ell, as usual.  Maybe it’s been a loser too long to be taken seri­ously any more.  And any pur­chase of the com­pany might come with a stigma of pay­ing up for some­thing that is already dead.  We’d have to take a closer look at Nov­ell to get a bet­ter sense of their soft­ware assets but all we can say now is that the com­pany is cheap. I’s on a TEV/Revenue of 0.5x and a bit over 3x tan­gi­ble book.

Look­ing over the list it cer­tainly appears that Sun stands out as the bar­gain.  Their soft­ware assets are far more strate­gic, they have a cadre of top-notch engi­neers and the mar­ket­ing, sales, dis­tri­b­u­tion and man­age­ment team can be reduced dras­ti­cally to improve prof­its and com­pany performance.

That JAVA has not declined back (or below) the $5 price where the IBM-Sun news started sug­gests that many agree Sun looks too tempt­ing not to pick up in this eco­nomic envi­ron­ment.  But the most log­i­cal (IBM, HPQ) would have anti-trust issues.  Cisco would be a real spoiler and game changer for IBM and HPQ were they to decide to do it.  Dell is sad­dled with too many of their own prob­lems.  Some have men­tioned Ora­cle and Microsoft.  See­ing either of those firms get into the hard­ware busi­ness in a big way is hard to picture.

If the Sun board doesn’t see a trans­ac­tion in the wings they need to bring an a new CEO if there is any hope to trans­form the com­pany into an worth­while equity invest­ment.  JAVA will be a great trad­ing vehi­cle for some but a dan­ger­ous stock for most.

[Dis­clo­sure: Research 2.0 has no posi­tion in JAVA at the time of this writ­ing.  See our web­site for more disclosures.]

Tagged as: IBM, Open Source, Sun Microsystems