NEW YORK (CNN/Money) -
Novell's stock is surging and the company has its sights set squarely on big, bad Microsoft.
No, you haven't stepped into a time warp. (It's just a jump to the left.) This isn't 1994, the last time investors got excited about Novell's chances against Microsoft.
But there's no mistaking the stock-price move -- Novell (NOVL: Research, Estimates) shares have gained 160 percent this year and nearly 50 percent so far in November.
Why? Two words explain the latest run: Linux. IBM.
Oh SuSE Q, IBM loves you, SuSE Q
Linux is an alternative operating system to Microsoft's Windows, and Novell has been increasingly hitching its cart to that wagon. On Nov. 4, the company said it would buy German software developer SuSE Linux, a move that investors are betting will help Novell compete not only against Microsoft (MSFT: Research, Estimates) but other Linux vendors like Red Hat (RHAT: Research, Estimates).
But the news that really sparked Wall Street's interest that day was the fact that IBM (IBM: Research, Estimates), which is also aggressively pushing Linux, agreed to purchase $50 million of Novell convertible preferred stock.
So Novell is ready to fight the good fight once again, this time as a Linux company...and with the backing of a true tech heavyweight. Still, is there any reason to believe that the results will be different this time around?
Novell made a name for itself as a successful developer of an operating system for networks, known as NetWare, in the 1980s and early 1990s.
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The company stumbled when it tried to take on Microsoft in the desktop office software market. Novell bought WordPerfect and Quattro Pro (which competed with Microsoft's Word and Excel) in 1994, only to sell them two years later to Corel.
In addition, NetWare started to lose ground once Microsoft launched its own network operating system, Windows NT. Novell's sales and earnings deteriorated in the mid-1990s but fundamentals started to improve again during the late '90s tech boom.
After the bubble burst in 2000, Novell went into another tailspin, reporting big net losses in fiscal 2001 and 2002. The company reported its fiscal fourth-quarter results Thursday afternoon, and although it posted a profit before charges of 5 cents a share, sales fell 4 percent from the same period a year ago.
Smart strategy, expensive stock
Novell is hoping to re-establish itself as a leader in the networking software world by selling customized versions of Linux software. Novell bought another small Linux company in August.
This does seem like a smart decision as open-source computing is gaining in popularity with corporate customers, particularly as concerns about security continue to dog Microsoft.
Novell also owns a tech consulting company, having acquired Cambridge Technology Partners in 2001, that can hawk its Linux offerings. And the more software licenses you sell, the higher the maintenance and service revenue down the road.
Gideon Kory, an analyst with Roth Capital Partners, wrote in a recent report that "Novell's evolving leadership position as a Linux/Open Source champion contributes to the company's new image and is a key driver for the company's growth." He doesn't own the stock and his firm has no investment banking ties to Novell.
But this might be factored into the price already. Analysts expect Novell to post earnings of 22 cents a share in 2004. So Novell is trading at 41 times 2004 earnings estimates, which is no bargain.
Even if you assume that this estimate is too low, it's hard to envision the stock becoming cheap anytime soon. Say estimates increased to 30 cents a share. You're still looking at a stock that's trading at 30 times earnings.
In addition, there's a fair amount of legal risk. SCO Group (SCOX: Research, Estimates), a technology company that owns several patents for the Unix operating system, is suing IBM, claiming that Big Blue has transferred some Unix code to versions of Linux. (For more about this, check out Eric Hellweg's SCO's case gets clearer.)
SCO is demanding that Linux users pay it license fees and has hinted that it may file lawsuits against other Linux companies, such as Novell. This is murky stuff, but it should not be ignored.
If SCO does sue Novell, then the company will find itself with higher expenses than planned. And if SCO actually wins, Novell's Linux business won't be as profitable. SCO, by the way, is being represented by high-powered attorney David Boies, one of the lead prosecutors in the Department of Justice's antitrust case against Microsoft.
Novell certainly should be applauded for making wise strategic moves to stay relevant, especially since so many erstwhile Microsoft competitors have faded into obscurity.
But after a 50 percent pop in the stock in less than a month, admiration shouldn't be mistaken for a buying opportunity.
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