p2pnet.net News Feature:- If we told you that a company was amassing a cash stockpile which was three and a half times its current annual revenues, that it has employed a new director who used to work for Cisco, that it has acquired a business last week and also had a brand new CFO that was used to working in far, far larger companies, you’d think that this was a company hellbent on acquisition. And you’d be right.

So if we tell you that it’s a US software company that’s been about for more than a decade, you might guess it is Oracle perhaps, or one of the big business intelligence firms like Cognos, or a software development business like BEA.

It is, in fact, tiny Red Hat, primed and ready to take its long awaited place in the big time, by going on a spending spree, buying technology to fit around its almost ubiquitous enterprise Linux implementation.

But behind that strategy, viable and necessary as it might be, lies a business that is already profitable, growing in momentum, and which is poised to benefit from a major rise in Linux desktop licenses, something in the past that it was loathe to get involved with.

CEO Mathew Szulik, seems to have deliberately orchestrated this situation over a matter of a few short months. It’s almost as if he said, “Ok I’ve had enough of this, let’s go for it.”

At an investors conference last month Szulik threw down the gauntlet to Sun, claiming two huge wins, and pre-announced its first ever 10,000 seat desktop Linux license.

So far, after ten years (the company was launched in 1993), Red Hat’s run rate stands at substantially under $200m for the last 12 months. The last quarter it had revenues of $46m, and $88m for the half year, and yet due to the promise of Linux, Red Hat retains a market capitalization of $2.44bn.

So is Red Hat set to become the Cisco of Linux and build via acquisition? Are there enough Linux software properties out there for the company to buy? Regardless it certainly looks like it is gearing up to try.

In October Edward Kozel joined the board of Red Hat. Kozel comes fresh from Integrated Finance, a consulting group that specializes in advising big companies on their financial strategy, including M&A activity. In 2001 Kozel was at Cisco, and before that worked at a venture capital group. All of that says that this guy is a regular takeover specialist.

Red Hat also just completed the raising of $600m in convertible debentures in a move designed to give it the financial muscle to acquire companies and to extend its application suite and build its business in Europe and the Far East. Europe so far has been a weak spot when compared with the German originated SuSe Linux, now owned by Novell.

Red hat had intended to get its hands on just $500m, but the subscription interest was so high that it chose to issue more debentures at the last minute. Again a move aimed purely at giving it the latitude to buy, buy, buy, as and when it finds the right targets.

The move leaves it with $997m of cash in the bank, and it was cash positive to the tune of $30m for the quarter, so its coffers are currently getting more full each day. And as the market undulates we wouldn’t be at all surprised to see it go back to the market again and again.

The other change is the sudden arrival of Charles Peters as CFO of the company, just four weeks before the end of the quarter address. Peters hails from Burlington Industries, an international fabrics company that was sold last year just as it came out of Chapter XI. He is described as a seasoned professional with experience in international finance and had stints at Price Waterhouse, GenRad and Boston Edison.

With the cash and the advisors in place, CEO Szulik has been fast to move, and has followed up Red Hat’s December acquisition of Sistina Software, by buying some of the key assets from the corpse of Netscape this week, which were held by the AOL segment of Time Warner.

Red Hat has agreed to pay $20.5m in cash to buy effectively two pieces of software which came out of Netscape’s Enterprise Solutions business, its Directory Server and its Certificate Management System.

The deal is expected to close by the third quarter.

The Directory Server is an LDAP server which is a way of building an enterprise global directory, which keeps track of employee system access rights, and is a central point for updating things like passwords, email addresses and even phone numbers and PC user settings.

LDAP stands for Lightweight Directory Access Protocol, and came out of reducing the size and increasing the speed of the ISO X500, an ancient directory standard.

The best known global service directory is probably Novell’s NDS which grew out of the side of Netware, and when Novell took the decision to transport NDS to its own Linux platform (the one it acquired when it bought SuSe Linux), along with putting Netware on Linux, Novell must have scared Red Hat into reacting.

Red Hat already has OpenLDAP, an open source implementation of the protocol, in its enterprise Linux distribution, but it probably feels the need to control the technology now that it has Novell breathing down its neck. Also a lot of money went into developing Netscape Directory Server back in the 1996/7 time frame, because it was one of the key ways the Netscape hoped to generate a revenue stream. So it is probably pretty functional compared to the OpenSource equivalents.

The Netscape Certificate Management System, which complements the LDAP server by authenticating user identities and providing a degree of privacy, is also a part of the deal.

The two products are expected to be integrated into the Red Hat Linux stable during the next six to 8 months and will eventually be available under open source licenses.

“We have been interested in this technology for a long time,” said Szulik, as he announced the deal at the company’s analyst day two weeks ago.

The LDAP market was once a very hot one in the run up to the launch of Microsoft Exchange and Active Directory, and was seen as an essential building block of a large enterprise email environment.

At the tail end of the 1990s Isocor, Novell, Netscape, Microsoft and even the ancient remains of Control Data and a host of others, debated the whys and wherefores of directory services, a debate that proved irrelevant once Microsoft established itself as the directory leader.

But as interest rises in desktops which are not Microsoft controlled once more, such as Linux desktops, that whole war kicks off again, which explains the acquisition very rationally.

When you add these products to the Application Server that Red Hat is pushing and its recently acquired Global File System (GFS), we can see that the Red Hat strategy is to build the price of entry into its market, and make sure its offering is right up there with everything that Novell can eventually offer. It has even taken a leaf out of Novell’s book and copied its famous certification and training program this year, to get as much money out of training Linux engineers as possible. Earlier this year it introduced its Open Source Architecture strategy and the related enterprise architect courses certification.

In December Red Hat bought the GFS when it paid $31m for storage infrastructure vendor Sistina Software. Sistina also offers a Logical Volume Manager, up against Veritas, which enables enterprise-level disk volume management by grouping arbitrary physical disks into virtual disk volumes.

Szlulik is nothing not combative. His company is up against Microsoft, and he fires endless shots off at Sun, and at the same time feels that his best strategy for growth includes matching Novell stride for stride.

In the comments accompanying the Red Hat third quarter figures he said, “In the last quarter we have one client that has used our product to replace 1,100 Solaris licenses. He found he didn’t just achieve a 70% cost improvement, but a 30% improvement in performance as well.

“We have another client, a chip developer, that had the confidence to replace 3,000 Solaris servers with our Advancer Server, the multi-node cluster version. These deals prove that Linux is accepted in the largest enterprises.”

It was then that Szulik sprang his desktop surprise. “This quarter a European retailer has ordered a rollout of 10,000 Red Hat Linux desktops,” he stopped short of giving up the company’s name, but even Sun would be hard pushed to come up with a win of that magnitude.

So the desktop battle has become important for Red Hat. At the moment Red Hat bundles a version of both the KDE and the Gnome desktop in Red Hat Linux as well as many Ximian systems such as its mailer, calendar and contact manager. Ximian is now also owned by Novell, and Red Hat must remain uncomfortable pushing its arch-rival’s product, albeit an open source version, every time it lands a deal.

Sun also has a full desktop product suite with Open Office which Red Hat distributes (it is called Star Office if comes from Sun with support). And as the world gradually accommodates Linux on the desktop, with several major organizations committed to moving away from the Windows bandwagon, Red Hat needs to feel well placed here.

Sun’s response to the purchase of Netscape’s software assets was predictable, describing the Directory Server as “antique” software saying that Red Hat used to go out and find the best open source software and include it in its Linux bundle, but now it’s buying the oldest commercial software around and making it open source.

But Netscape’s server development never stopped and the deal includes a team of around 50 programmers and Szulik reminded everyone that the directory software is included in Hewlett-Packard’s Web Server Suite for Unix. So, not so shabby.

Red Hat has also been trying to leave behind the dent it gave to its credibility when it decided to restate three years of financial results due to a new revenue recognition process.

That embarrassment may have something to do with the arrival of the new CFO, even though the company denies this is any part of the reason. It has also led to a stock repurchase plan with Red Hat buying back up to $100m of its securities in order to add some glister to its share price.

On the product side Red Hat is expected to integrate these new products by mid-2005, and will also add server virtualization in Red Hat Enterprise Linux 5, dropping its reliance on EMC subsidiary VMware for basic server virtualization.

What investors were told by Szulik this quarter will certainly give them the feeling that the product and financial plan is working and that this gradual roll out of an entire range of Linux-based open source applications puts Red Hat in the middle of the shift to Linux computing.

It already partners with many of the leading independent software vendors to the large enterprise, including Oracle, IBM, BMC, Computer Associates, EMC/Legato, Veritas, BEA, SAP, Peoplesoft and Network Appliance and on the hardware front has global agreements with Dell, HP, Fujitsu, NEC, Hitachi, Fujitsu Siemens and IBM.

For the quarter to August 31, it sold 144,000 subscriptions to Red Hat Enterprise Linux, and reported a net income of $11.8m, on $46.3m in revenue. Red Hat actually generated some $30.8m of free cashflow.

About 115,000 of those sales were made to Enterprises, while 29,000 licenses were sold to either high performance and scientific computing market, where 64-bit licenses are growing, or to the web hosting marketplace.

For the previous quarter ended May 31 Reed Hat sold just 98,000 new subscriptions and for the prior year, 169,500. So this quarter it has almost shifted the same amount of licenses as it did during 2003. And it’s clear that as long as Linux is in take off mode, Red Hat looks set to keep its revenues growing.

Linux researcher NetCraft, which tracks copies of Linux attached to the web, has Red Hat as supplying 1.4m active Linux licenses at sites on the internet, roughly 50% of all the Linux based web server licenses.

According to IDC’s Worldwide Quarterly Server Tracker reported in August that server revenue generally grew at just 6.9% with most of the growth coming in smaller servers.

But for Linux IDC says that this is the eighth straight quarter where Linux server revenues have grown at double-digit rates, up 49% at the mid year in revenue and with unit shipments up 38%.

This growth compares with revenue shrinkage in Unix and just 13.2% growth in the Microsoft server market and this gives an idea of what kind of growth Red Hat can continue to expect in new licenses.

But also as Red Hat adds more function to its distribution, it can charge incrementally more to its Linux support charges and extract better revenues from existing clients.

IDC says that this is the third consecutive quarter in which Linux servers have posted more than $900m in worldwide factory revenue, nearing the $1bn mark in quarterly revenue. Windows operating systems accounted for $3.4bn of server revenue, while for Unix this was $4.1bn in the quarter.

And the researcher says that now that version 2.6 is out it expects to see Linux servers move out of their pure infrastructure roles becoming mainstream for all server applications.

Ultimately Red Hat’s success could be its downfall. Many US analysts, the META Group in particular, have stated that Microsoft just HAS to enter the Linux market with its own applications, or risk ceding huge chunks of the market to open source. Microsoft’s Steve Ballmer says it’s never going to happen, but he has to say that to try to stall the shift to Linux.

And Novell, as we have said, is running head to head against Red Hat in its aim to produce the most complete architecture. Both have $1bn in the bank to fund acquisitions, and both are hell bent on making as much ground before Microsoft enters the space.

And as Red Hat’s Linux travels further up the Enterprise Server track onto bigger machines, which run more important jobs, we must expect the rate of take up to slow down, as buying decisions become slower in mission critical applications.

But for the next few quarters at least, expect those Linux license numbers to keep rising, and expect more acquisitions from both Red Hat and Novell as they jockey for position and hold just this one last thought, what a solid company they might make if they were to merge. Rethink wonders if the thought has even occurred to them.

Peter White – Rethink IT, UK

This entry was posted on Tuesday, November 2nd, 2004 at 4:14 pm and is filed under Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

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