September 27, 2000

Sunset for Cobalt?

Author: JT Smith

By Jack Bryar
NewsForge Columnist

Open Source business

A number of analysts claimed that the high price brought by Sun's
purchase of Cobalt Networks was proof of the value of Open Source. But
if so, why was Cobalt's Michael DeWitt trying so hard to avoid even
uttering the word Linux? And Sun's Scott MacNealy doesn't do high-priced
deals. Why did he pay so much for such a tiny company?
The dust is still settling from Sun Microsystems's announcement that
it was going to buy Cobalt Networks. As you may have heard Sun is paying
a half share of Sun stock for each share of Cobalt. At current
valuations that works out to nearly $59 a share, or roughly $2
billion, 40% more than Cobalt's recent trading range, and more than 40 times
gross revenue. Ed Zander, president and chief operating officer of Sun,
said, "We think can integrate it into the Sun product family and get a
big win here."

Sun v.p. Jonathan Schwartz characterized the purchase as an attempt by
Sun to take a piece of the low-end Internet market. He said, "We haven't
been penetrating the retail hosting ... bargain basement market. The
best path for us is to acquire our way into it." Maybe, but the way the
deal was structured and, and the premium Sun paid for what is still a
relatively small company suggests that Sun's motives weren't nearly that
simple. Zander said that Cobalt represented "a different model from what
Sun's been doing." It had to be a pretty important model, considering
the company effectively diluted its stock by nearly 15% to obtain

Among the most amazing aspects of the deal was that Scott MacNealy
paid top dollar for a very small (300 person) money-losing company.
Sun has bought relatively few firms and usually acquired them at bargain
basement prices. A couple of the analysts I spoke to suggested that
Cobalt had been shopping itself to several would-be buyers, and that Sun
was simply the high bidder. As evidence they pointed to the flurry of
recent announcements involving Cobalt, and firms like Yahoo and IBM, and
the fact that Sun COO Zander was in Boston rather than home at the
time the announcement was made. They suggested that Sun simply needed
the company more than IBM or any of the other IT and communications
hardware vendors. Rumors had been flying about a deal for some time.
Zander admitted, "This announcement shouldn't come as any surprise."

But why the high price? Zander said that Cobalt had effectively
discovered a fast growing new market which they dominated, they had
developed a direct sales channel, and they had developed an "appliance"
model that could be extended more deeply into telecommunications and
network area storage markets and to smaller companies.

Zander said, "Our goal is market share, market share, market share."
DeWitt agreed
. He said," It's all about market share. It's a
marketshare race." DeWitt said the company couldn't ramp up fast enough
without a major partner. He said, "What Sun brings to the table is
pretty straight forward. Sun has a sales force of 10,000."

According to Zander, Cobalt's management team was another reason the
company was willing to pay big bucks for the acquisition. He said,
"We're going to use the Cobalt team, and Steve DeWitt and his management
team, to really get us into the appliance space. And we ... hopefully will
expand their charter and to create more product space around this new
appliance model." At several points over the last couple of days, Zander
or members of his staff emphasized that they planned to ramp up staffing
to support the Cobalt team, with new hires in R&D and elsewhere.

While neither Zander nor DeWitt wanted to talk much about the future
direction of Cobalt, Zander hinted that the Cobalt's appliance model
would be aggressively extended into Network Area Storage systems. Zander
said, NAS "is key for us"

Not surprisingly, Sun's competition pronounced itself unimpressed by
the deal or its price tag. Dell Computer's Michael Dell said, "The fact
that Sun paid 40 to 50 times revenue for Cobalt is interesting. We
created the PowerApp (appliance server) pretty quickly ... and we didn't
spend $2 billion." Dell and other hardware vendors including
Compaq, Intel and HP, have been trying to break into the market with
smaller, dedicated Web servers of their own. Perhaps Dell would have
been even more caustic if Dell's appliance servers vendors sold a little
better. Earlier in the week, Dell was scolding his customers for their
slow adoption rate, saying, "I'd give businesses a C-minus on Internet

For their part, the investment analyst community gave the Cobalt deal
an "A". Daniel Kunstler of J.P. Morgan praised Sun's decision to buy Cobalt, as did analysts at ABN Amro
and Hambrecht & Quist. They think that Sun's sales and support team
will help put Cobalt's in a position to win the market decisively and
they were generally upbeat. Even though the purchase resulted in a
significant dilution of the company's stock, Sun shares actually rose
slightly, to close at 117.69.

Was this good news for the Open Source community?

On the day of the announcement, VA Linux had a quick spike in trading
volume and its price jumped briefly by nearly 20%. Keith Bachman of ABN
Amro said it was due to the Sun/Cobalt deal validating the market value of
the Open Source model.

Cobalt's DeWitt would have none of that. Asked directly if Linux was
a critical part of Cobalt's value proposition, DeWitt said, "Not at
all." He said, "We are an infrastructure company." According to DeWitt,
"The value proposition" Cobalt provides "does not include the operating
system." In fact, "[We] need to shelter people from the complexity of
the operating system," DeWitt said. Coming from the No. 1 vendor of Linux
based appliances, DeWitt's frequent references to his company's software
as a "platform" and as key "intellectual property" were particularly

As for Sun, Zander said, "We did not approach Cobalt with the word
'Linux' pressed on our foreheads. More important was the appliance thing." According to Zander, "We
have no problem with Linux. We just think we already have the world's
best operating system in Solaris." Zander said, We have been very active
in the Open Source movement ... We run Linux apps on top of Solaris. We
just don't want to do Linux across the board the way some of these other
companies are doing."

So is the Sun/Cobalt deal a repudiation of Open Source, or is it
further evidence that the movement has moved into the mainstream?


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