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VA Linux Tries to Overtake Red Hat


by Hal Plotkin
Silicon Valley Correspondent

Investors continue to buy into the Linux craze, making today’s VA Linux Systems’ IPO the best-performing debut in Wall Street history. The stunning debut makes VA Linux the new poster-child for the Linux business, replacing previous IPO darling Red Hat.

Shares in Sunnyvale, Calif.-based VA Linux {LNUX} jumped to $300 this morning, after pricing its 4.4 million share offering earlier Thursday at $30. It closed at $250, posting a staggering 733 percent gain on the day. (The previous one-day record holder was theglobe.com, which jumped 606 percent on its debut last November.)

Durham, N.C.-based Red Hat {RHAT}, which opened for trading on Aug. 11 and posted a 274 percent gain to $52 a share on its first trading day, currently trades at $286 1/4.

So in one day, VA Linux has almost caught up to Red Hat in terms of share value, even though Red Hat had a nearly four-month lead.

Why the hype over VA Linux?

For starters, VA Linux is the first pure Linux-oriented hardware vendor to hit Wall Street.

“VA Linux has had phenomenal growth over the last four or five quarters,” says Bill Peterson, research manager at International Data Corp., based in Framingham, Mass. “The company is very well thought of in Linux circles, they have their management in place and their customer base is strong and growing.”

Like Red Hat, VA Linux sells and supports a version of the free Linux operating system. However, VA Linux is better known in the industry for its sales and servicing of Linux-based servers, which are used to power Web sites and internal corporate networks.

“VA is not Red Hat,” says Stacey Quandt, an analyst at Giga Information Group based in San Jose, Calif. “We’re talking hardware, not software.”

The company has positioned itself to take advantage of projected strong sales of server appliances, which are servers designed to accomplish a specific task, such as handling e-mail or storing Web pages locally for faster retrieval, in addition to selling general-purpose Linux servers, which can be configured for a variety of uses.


Red Hat Post-IPO Stock-Performance Chart

Despite Red Hat’s strong post-IPO performance, Kimball Brown, chief analyst at Dataquest based in San Jose, Calif., urges caution when it comes to VA Linux.

Brown’s restraint stems from two factors: concerns about the overall viability of the Linux-oriented business model on the software side and worries about how VA Linux will fare over the long term, in the competition on the hardware side with much larger firms.

“I don’t see this as another Red Hat,” Brown says. “They are by far the No. 2 shipper of that kind of [Linux] software. I have a real hard time understanding why Red Hat has the market capitalization they have. It’s possible, by the same token, that VA Linux gets that same kind of valuation. But once the big guys wake up, we’ll see what happens then.”

The big guys Brown refers to include Compaq Computer Corp. {CPQ}, Dell Computer Corp. {DELL}, Hewlett-Packard Co. {HWP}, Silicon Graphics Inc. {SGI}, and, potentially, Sun Microsystems Inc. {SUNW}.

All those firms, to one degree or another, are or will soon be selling Linux-powered servers that compete with the servers sold by VA Linux.

Quandt says that VA Linux’s one advantage over those much-larger firms is the company’s exclusive focus on the Linux market. “That’s their value proposition,” she says.

Peterson agrees. “A lot of server companies say they support Linux, but when it comes right down to it, many of the bigger players are not doing very much.” That, he says, could give VA Linux an advantage with some customers. “If you’ve decided you want to install a Linux server, you might want to go with a company that specializes in that area,” he adds.

Unlike a few years ago, few analysts seem to doubt Linux’s growing role in the high-tech industry. The question now, however, is exactly which companies stand the best chance of reaping the rewards of that growth.

When IDC surveyed corporate information technology buyers in 1997, for example, 0 percent reported deployment of Linux-based systems in their businesses. Last year, that figure had jumped to 13 percent. Peterson says he expects the number to be considerably higher when IDC’s 1999 figures, which are now being compiled, are released. “We’re finding Linux popping up in much more places than in our last survey,” he says.

One reason for Linux’s growing popularity is that, unlike proprietary software products sold by companies such as Microsoft Corp. {MSFT}, the vendors of open-source software products such as Linux make the source code of their products freely available. Armed with the source code, programmers can modify or improve software without needing the help or permission of the original manufacturer.

“Everyone who uses open-source software can benefit whenever the software is improved,” Quandt says.

IDC projects a 25 percent compounded annual growth rate for Linux-based server operating systems over the next four years, as compared with a projected compound annual growth rate of 10 percent for Microsoft’s competing Windows NT operating system over the same period.

Likewise, Dataquest estimates that Linux servers, VA Linux’s’ bread and butter, will account for about 24 percent of worldwide server-appliance revenue, or $3.8 billion, over the same time frame.

“At some stage the behemoths in the industry are going to wake up to that,” Brown says. “I’m not sure where that will leave VA Linux Systems, though.”

Brown says that point was brought home to him vividly last week while he was attending a trade show for Internet service providers in San Jose, Calif. “Microsoft and Novell had their booths at the show,” he says. “But outside of their booths you never heard them talked about. Everywhere else, it was all Linux and free software. It was fascinating.”

Brown says the lesson can’t possibly have escaped the attention of the largest server vendors, who he says can be expected to ramp up their head-to-head competition with VA Linux in the Linux server market.

Peterson concedes the point but maintains that VA Linux will continue to enjoy a competitive advantage over larger rivals because of the company’s strong following in the Linux community.

“They’ve attracted some of the best minds among Linux developers,” Peterson says. “They own the Linux.com Web site. The bigger companies are taking basically a “me-too” approach to Linux. But, I’m pretty confident VA Linux Systems is positioned to do very well.”

VA Linux posted a loss of $14.5 million for the fiscal year ended July 31, on revenue of $17.7 million, as compared with a profit of $84,000 on revenue of $5.5 million in fiscal 1998.

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