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Taking stock of Linux
August 9, 2001: 8:27 a.m. ET

Rival to Microsoft operating system a growing force in the server market
By Staff Writer Richard Richtmyer
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NEW YORK (CNNfn) - Remember the Linux frenzy of late 1999 and early 2000? A lot of investors would probably rather forget.

The stocks of companies that specialize in Linux have been among the hardest hit by the technology sector's precipitous decline. But at the same time, enthusiasm for and adoption of the Linux operating system software has continued to grow.

Linux is an "open-source" operating system. That means the underlying code that makes it work is available for anyone to view and modify, as long as they share their modifications with the rest of the Linux community. It's widely available for free on the Internet, but several companies have emerged that offer for sale their own versions of the software, as well as attendant support and services.

Linux has been seen by many as an emerging rival to Microsoft's ubiquitous Windows operating system and has been gaining strength in the server market, especially among dot.coms.

Technology research firm International Data Corp. recently said Linux, which originally had a cult following of technically sophisticated users, represented 27 percent of new server software license in 2000, while Microsoft's Windows represented about 41 percent. The report showed that Linux is growing at a rate of 24 percent to Microsoft's 20 percent.

The growth rates can be attributed in large part to heavyweight computing companies such as IBM and Hewlett-Packard and Compaq, which recently have thrown their weight behind Linux.

Linux fever breaks

In late 1999 and early 2000, as the balloon expanded, stock market reports were peppered with phrases like "Linux mania" and "Linux fever" as the promise of the new operating systems had investors converging on shares of companies that were connected to it in any way.

That enthusiasm reached its peak in December 1999, when VA Linux (LNUX: down $0.04 to $2.00, Research, Estimates) went public on Nasdaq, ringing up a 733 percent first-day return, a record at that time.

Just a few months before that, Linux specialist Red Hat (RHAT: up $0.08 to $3.81, Research, Estimates) went public, its shares priced at $14 and then soared 233 percent on their first day of trading. A few months later, Linux software specialist Caldera Systems (CALD: down $0.01 to $0.70, Research, Estimates) made its market debut. Its shares also priced at $14 and posted a 118 percent first-day return.

Each of those stocks now trades well below its initial offering price.

Much of the blame for those losses can be laid on the slowing economy and the sharp downturn in the broader technology sector this year. But current lack of interest in Linux stocks also could be due in part to a general misunderstanding about the open-source concept among the current group of investors which may want to buy them, according to Brent Williams, software analyst at McDonald Investments in New York.

During the Linux frenzy of late 1999 and early 2000, many traders bid the stocks up because they kept going up. Day traders and tech-savvy individual investors also played a part, Williams said.

Now, potential Linux-stock investors are more focused on things like value and consistency in earnings, making investor outreach very important.

"There's a certain amount of rotation of different types of market participants, and now you've got to come in all over again and say, 'OK, here's how you can make money by selling software that people can download for free,' " Williams said. "A new crowd of people now has to understand that."

"All these guys need to go out and make it really clear what their business model is, continue to broadcast that and continue to execute on what they say they're going to do," Williams added.

Larry Augustin, VA Linux's chief executive, said the Linux industry currently is in a transitional period, similar to the one the industry has gone through over the past year.

"The businesses started out with all these different business models. It wasn't clear that anyone really knew how they were going to make money, and we've had that fallout and transition," Augustin said. "At the same time, a lot of established businesses picked up on the Web."

"I think you have the same kind of transition happening in the Linux market, Augustin added. "In the same way the Web isn't dead just because all of these dot.coms have gone out of business, the Linux market isn't going to be dead just because there are going to be some Linux companies that are going to go out of business."

For its part, VA Linux has been adjusting its business model to adapt to the changing industry environment. The company, which originally had sold hardware, software and services aiming specifically at dot.coms, has retrenched.

It has decided to exit the hardware business and now focuses specifically on selling software and support services that help large corporations develop specialized software more efficiently. The decision to exit the hardware business was prompted in large part to avoid going head-to-head with larger, deep-pocketed companies such as IBM and HP, Augustin said.

"We're in a transitional period, and what's important is that the Linux companies pick up business models that are viable and continue as more of the established existing companies do more about Linux," he said.

A $1 billion plan

Meanwhile, companies like IBM, which has announced plans to spend nearly $1 billion on its Linux efforts this year, prepare for what they expect to be the next wave of growth.

"It's important to separate what's happening with some of these Linux-related companies from what's happening with Linux," said Steve Solazzo, vice president of Linux at IBM.

Four years from now, IBM is betting that Linux will be second only to Windows as the highest volume enterprise operating systems. And as it becomes a more dominant operating system, it will prompt the formation of a "value net" surrounding IBM's business, Solazzo said.

"The reason we're spending all this money is because we see this new value net forming," he said.

He said much of the money IBM has earmarked for Linux is going to application providers to help them develop their applications on Linux. The company also has been spending a lot of it on university programs so that as those university students study Linux they also study things like IBM databases that run on Linux and IBM Web servers that run on Linux. The company also has been spending it on business partners and system integrators to help build their Linux skills, Solazzo said.

IBM also has partnered with four of the leading Linux software distributors: Red Hat, SuSE Linux, Turbolinux and Caldera.

"We think that as this market rationalization occurs, there's not going to be just one company left standing, but there certainly will be a handful of strong companies," Solazzo said. "And we've picked four of what we think are some of the best companies, and we have very strong partnership relationships with them." graphic