July 19, 2002

Open Source and the next boom

Author: JT Smith

- by Jack Bryar -

With the stock market taking a dive, and business pessimism setting new
records, are there any hot prospects left in all of high tech, let alone those
beleaguered remnants of the Open Source business community? Actually, yes. At least
one Open Source company is at the center of one of the hottest developments
in technology. Another is being rescued by companies in what was
supposed to be the one business sector in worse shape than the computer
In fact, despite a pounding by so-called stock experts, many Open
Source firms have ridden out the last couple of weeks in surprisingly good
shape and may be in a great strategic position in the near future. There's a
surprising reason for this.

The last week or two have been simply hideous for anyone whose life
savings are tied up in 401k accounts. The tech sector has borne the brunt of the stock
market's "irrational pessimism." The valuations of firms like Cisco, Sun
Microsystems and Oracle have all taken a hammering. Much of the pounding has been
the inevitable backlash from a decade featuring a hyped market, immature
management, lax regulations, creative accounting and bloated executive

As the panic has escalated, even innocent companies are being
downgraded by so-called investment pros.

Take Red Hat. Despite having enjoyed an almost uniformly favorable
press, and having garnered over half the commercial Linux operating system market, the
financial analyst community has been trashing the firm over the last 10 days.
Although there was little in the company's recent Analysts Day and Earnings forecast to justify it, last week the company landed on the analysts'
collective dung heap. Few analyst's cheat sheets are followed more closely than
the First Call "Consensus Recommendations List." The list measures those
companies showing the greatest swing in sentiment among investment analysts. This
week, Red Hat found itself placed on the list, as one of the lowest rated,
least promising of all publicly traded stocks. This is the current list that includes
firms such as WorldCom and U.S. Airways. It is hardly a place any company
wants to find itself.

Unfair? More mindless piling on by the same clowns who hyped up this
stock and lots of others during the the dot-com bubble? Probably all that.
Nevertheless, critics are complaining that generous executive pay and stock options
have kept the company from being consistently profitable, and the remarks
have some merit. Despite such sentiments, Red Hat's stock price has stayed
relatively stable over the last few weeks, especially compared to many other IT

Perhaps all the panic-prone investors had already run away during the
company's stock swoon of last winter. However, Red Hat's recent experience has
been mirrored by other Linux firms, including some firms in real financial
trouble. For example, in the past two months, Caldera has replaced its CEO and CTO and
hacked away better than 15% of its workforce. Key investors pulled
out. Despite all this, Caldera's stock has actually been going up over the
last three weeks.

This may be a sign that the bear market of 2000-2002 is be coming to a
close. Near the end of such markets, the most undervalued businesses see a rise
in the valuations as bottom feeders look for cheap stock. Several Open
Source companies may look particularly cheap to these so-called "value"
investors. Borland Software is a good case in point. It bothers many investment
pros that Borland does such a large percentage of its business with the
major telephone companies, a sector generally given up for dead. However,
several institutions have noted that the company's current stock price works
out to less than the company's annual revenues, and not much more than
twice the cash Borland has in the bank. They have also noted that Borland
continues to be profitable every quarter. That's something few IT firms not named
Microsoft can claim these days.

There appears to be more going on than just bottom fishing for
bargains. Another reason some strategic investors have renewed their interest in
Open Source is the dawning realization that Open Source companies don't have
the same basic strategic problem that faces most of their competitors.
Unlike nearly everyone else in high tech, they aren't seeing their business
plans damaged by ... Open Source.

It is one of the great untold stories of the computer industry. Open
Source has grown to become a classic disruptive technology. Firms such as
Oracle, Dell, and Sun have yet to formulate a coherent response to the
challenges of Linux. As a consequence, they face increasing levels of uncertainty
and doubt from business purchasers. Many business customers still hesitate to
embrace open platforms but refuse to do business as usual with their
traditional, proprietary vendors until everyone has figured out how to incorporate
Open Source into their business environments. Some of this Open Source FUD
has been fueled by marketing practices of firms like IBM, which have hyped
Open Source to beat up its competitors. InfoWorld's Michael Vizard has been particularly critical of IBM's strategy and motives, but such doubt and paralysis is natural to any market undergoing radical change.

New technologies spawned by the Open Source movement are even more
disruptive. Take grid and cluster server technology. Some time back, Irving
Wladawsky-Berger, IBM's strategy guru, predicted that grid systems and cluster server
technology would revolutionize the IT market. There's
plenty of evidence to suggest he is right. As part of a project at my day job,
I have been tracking wire service press releases concerning
businesses and institutions that are setting up grid or cluster systems. The
stories are now coming in at the rate of two to three a day.

One recent article concerned the monster Linux cluster system being
constructed for Lawrence Livermore National Laboratory. When complete, the cluster will combine 1,920 Xeon CPUs into a system capable of generating 9.2
trillion calculations a second. Unfortunately for chip makers like Intel, grid
and cluster architecture means that the fastest way to improve overall
performance may not involve paying big money to buy the next generation of
Itanium 2 CPUs. The Xeon chip was new in 1998.

Every disruptive technology has winners and losers. Among the winners
appear to be firms betting heavily on cluster server technology. Perhaps the
most focused of these firms is Linux
. Spawned by Glen Lowry's Alta Technology Corporation, and underwritten by
Wasatch Ventures, Linux NetworX is building systems for governments, institutions
and an increasing number of engineering and pharmaceuticals
companies. The company's finances are private. Its management has been shaky. The
company is unlikely to go public any time soon until the markets stabilize.
However, the success of Linux NetworX and the technical advances being made by
other Open Source firms have attracted a new round of interest from a species
of investor thought to be extinct, the venture capitalist.

It may be counterintuitive, but a crash of the type seen on Wall Street
this week tends to flush money back into venture funds. When blue chip
stocks begin to crash, there are few safe havens, and almost no other high-growth opportunities outside of new start-ups. As a result, money is starting
to come back into the venture markets. The Boston Globe recently covered
the expanded activities of Orange
, a venture capital team with a quarter billion dollars worth of
spending money underwritten by a European wireless firm. Another European
wireless company just set up a similar fund in Manhattan.

These firms are all looking for companies capable of providing wireless
Web services, collaborative computing environments and improved back-end
systems architecture. These are all businesses areas where Open Source ventures
should do particularly well. So, if the current stock market bust marks the
beginning of the next boom, Open Source developers face an interesting challenge. The
technology is there. The money is starting to show up. The market is beginning to
stabilize. Will businesses be ready?

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