June 1, 2004

BayStar cashing out of SCO Group investment

Author: Joe Barr and Chris Preimesberger

BayStar Capital, the Larkspur, Calif., hedge fund that invested $20 million of a $50 million private interest in public equity (PIPE) deal last fall to keep the SCO Group afloat, is now washing its hands of the whole deal -- less than eight months later.

SCO Group Tuesday announced the repurchase of all 40,000 shares of its Series A-1 Convertible Preferred Stock held by BayStar. The agreement calls for BayStar to receive $13 million in cash and 2.1 million shares of common stock from SCO Group. SCO's common stock is currently selling for $4.81.

Following Tuesday's transaction, BayStar will be left with a total investment value of about $10.1 million in SCO Group.

BayStar tried to redeem its entire investment on April 15 but was refused by SCO Group CEO Darl McBride. BayStar told NewsForge eight days later that it didn't believe SCO's senior management was experienced enough in IT litigation to fully reap the financial benefits from the company's intellectual property.

SCO Group's biggest value is in its intellectual property ownership, BayStar spokesman Bob McGrath said at the time, and not in its Unix products and services. SCO Group reported income of about $11 million in Unix products and services (ongoing contracts) and a meager $20,000 from SCOsource initiatives -- new business -- last quarter. "We still think SCO Group has a strong story in the value of its IP," he said.

"It's questionable whether SCO Group should continue in the [Unix] market," McGrath said. "We're looking for the best return we can, and we think the focus should be on IP licensing [and enforcement]."

SCO Group has not changed any of its key management personnel since then.

A source close to the transaction told NewsForge Tuesday that the SCO Group rebuff of BayStar on April 15 was the event that started the ball rolling toward this latest financial move.

As a result of Tuesday's transaction, BayStar relinquishes virtually all of its influence in the overall direction of the SCO Group, although it still owns 2.1 million common stock votes. BayStar no longer will have a seat on the company board of directors, will not be consulted on strategic SCO Group projects and initiatives, and will not be eligible for preferred dividend rights.

BayStar bought 20,000 preferred shares from its PIPE deal partner, the Royal Bank of Canada, on May 7. On that same day, when the stock was trading at $5.98, RBC transferred its remaining 10,000 shares of preferred (non-voting) stock into 740,740 shares of common (voting) stock. As a result, there are no preferred shares of SCO Group stock outstanding.

"After productive and substantial discussions with SCO's management team, board of directors and legal team, BayStar is extremely satisfied with SCO's current operating and cash management plans, new initiatives, management of the litigation, and plans for improving its business going forward," Larry Goldfarb, BayStar's managing general partner, said in a statement that did not jibe with statements he made to the New York Times several weeks ago.

Goldfarb told the Times he was concerned that SCO Group's priorities aren't in the right place, and that company executives were spending too much time and energy "in publicity and debate" with open source advocates about Linux, rather than focusing on legal strategy.

McBride said in the announcement that SCO was pleased with the repurchase since it would "eliminate restrictions, covenants, preferences, accruals for dividends, and allow the company greater flexibility to manage key aspects of its strategy moving forward."

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