Fact and fiction in the Microsoft-SCO relationship

Fact and fiction in the Microsoft-SCO relationship

Summary: SCO's fight against Linux has conspiracy theorists buzzing over Microsoft's role in the affair. What are the facts?

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TOPICS: Software
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The SCO Group's legal actions against Linux have shed light on the inner workings of the open-source programming project and on the operations of a company desperate to survive. They've also created a cottage industry for conspiracy theorists over Microsoft's role in the affair.

SCO's attack, based on the company's disputed claim of Unix copyright ownership, and with IBM as the main target, has been bold and expensive. Lindon, Utah-based SCO hired the pricey but high-profile attorney David Boies (of Microsoft antitrust and Napster fame) to launch the attack at a time when product revenue was shrinking and cash was dwindling.

But it was Microsoft that helped ensure that SCO could mount the fight, by providing major financial help at least twice in 2003. (SCO's finances are currently being tallied for the quarter ended Oct. 31, with the results to be reported in late December.) Though it doesn't appear that Microsoft was in the driver's seat when it came to SCO's legal attack on Linux, Microsoft's financial assistance was unusual and crucial.

Naturally, the arrangement has captured the imagination of legions of conspiracy theorists worldwide. And why not? In one corner you've got a tech Goliath that has dominated the PC industry by humbling companies ranging from giant IBM to former Net darling Netscape. In the other corner stands the company's new nemesis, Linux, an underdog operating system that has thousands of devotees preaching its virtues and, more importantly, contributing to its growth.

In an effort to separate fact from fiction, CNET News.com presents the following answers to some of the more common questions swirling around the SCO-Microsoft relationship.

Has Microsoft's money been a significant resource for the financially ailing SCO?
Without a doubt. In early 2003, Microsoft started paying SCO what eventually grew to $16.6 million for a Unix license, according to regulatory filings. Only longtime Unix fan Sun Microsystems previously paid close to that, with a $9.3 million license deal.

Microsoft provided a second, though indirect, boost in August or September of 2003, when it referred SCO to BayStar Capital, a fund that arranged a $50 million investment.

"Microsoft obviously has an interest in this, and their interest is obviously in keeping their operating system on top."
--Larry Goldfarb
managing partner, BayStar
SCO chief Darl McBride has been up front about the importance of Microsoft's funding, direct or otherwise.

"A year ago we had $6 million. Now we have $60 million, with $50 million of that coming in through the investment. We have a war chest to defend our rights, to fight our claims in the courtroom," he said earlier this year, adding that the cash is enough for the long haul. "We think the legal battles we have won't even go through half that amount of cash, even played over a multiple number of years."

Most of that cash is now gone: SCO paid most to its law firms and to retire BayStar's preferred stock.

Paying the license fees could indicate that Microsoft simply believes SCO's Unix ownership claims have merit. But doesn't arranging the BayStar investment reveal Microsoft's ulterior motive? After all, why would you want to help prop up a company that is demanding millions in royalty fees from you?
That may not be far off the mark, according to a key BayStar executive.

"Microsoft obviously has an interest in this, and their interest is obviously in keeping their operating system on top," says Larry Goldfarb, managing partner of BayStar.

Without naming names, Goldfarb explained that BayStar received a call from a "senior" Microsoft employee, but not Chairman Bill Gates or Chief Executive Steve Ballmer. "When they started telling me what it was, I wasn't shocked (that) this was something they'd like to see prevail."

Is the licensing agreement unusual for Microsoft?
Not only was the license fee the largest SCO has yet landed, but Microsoft's willingness to write a check also contrasts with its behavior in the 1990s when SCO's predecessor, the Santa Cruz Operation, tangled with the software behemoth over a 1987 Unix contract. In that case, Microsoft dug in its heels and the dispute was settled only by a European Commission ruling.

Is Microsoft more than a passive participant? Is it driving the decision to take IBM (and Linux) to court and to sow FUD--fear, uncertainty and doubt--among corporate buyers?
Is Microsoft more than a passive participant? Is it driving the decision to take IBM (and Linux) to court and to sow FUD--fear, uncertainty and doubt--among corporate buyers?
There's been some smoke, but no smoking gun. And SCO has its own survival in mind in taking IBM to court.

Although Linux threatens Microsoft, SCO was a convenient ally rather than a Microsoft puppet in the Linux fight, maintains Illuminata analyst Gordon Haff. "There are people associated with Microsoft who have done things that directly or indirectly have aided SCO's cause," Haff said. "But I don't subscribe to Microsoft being a driving force behind this."

What's Microsoft's and BayStar's response?
Although BayStar and SCO confirm Microsoft's role in introducing them, Microsoft stands by earlier statements of independence: "Microsoft has no direct or indirect financial relationship with BayStar. Our financial dealings with SCO are limited to the purchase of a license to SCO's intellectual property to ensure IP compliance and assurance for our customers." (A Microsoft product called Services for Unix lets Unix software run on Windows.) However, Microsoft will not provide the name of the executive who introduced SCO to BayStar.

BayStar's Goldfarb bristles at suggestions that Microsoft is running the investment show.

"That Microsoft is behind BayStar--it's just absurd. For us it was a straight-on financial investment based on the merits of the case, end of story," Goldfarb said. "It was all our money. They don't invest in my fund."

Goldfarb added that Microsoft also "has zero connection" with the Royal Bank of Canada, which put in $30 million alongside BayStar's $20 million for the October 2003 investment. RBC has joined in other BayStar investments, including XM Satellite Radio.

Even with the facts as known, isn't Microsoft breaking the law?
Apparently not, though the company was aware that it could be walking a fine line.

Microsoft's referral to BayStar came during discussions in August or September 2003 when SCO offered the software giant a chance to invest, McBride said in an interview.

"That Microsoft is behind BayStar--it's just absurd. For us it was a straight-on financial investment based on the merits of the case, end of story."
--Larry Goldfarb, BayStar
Microsoft declined the offer, however, saying it didn't want to cause problems with the settlement agreement resulting from the Justice Department's antitrust suit, according to Chris Sontag, who runs the SCOsource effort to recover money from the Unix intellectual property.

"They're very careful and concerned about not doing anything that's violating their DOJ agreements," Sontag said. While not commenting specifically, Microsoft didn't deny Sontag's account.

Nevertheless, doesn't that represent a smoking gun that the Justice Department should at least be interested in?
No, at least not yet. The Justice Department case labeled Microsoft a monopolist, but legal experts have a hard time finding how its SCO ties violate either antitrust laws or the settlement with the DOJ--unless Microsoft acquires SCO, which is a competitor as well as a partial ally.

"If I thought Microsoft might be violating the law, I would be delighted to tell you they're violating the law. I have said they are on hundreds of occasions," said Robert Lande, an antitrust law professor at the University of Baltimore School of Law. "But I don't think so far, on the basis of the facts, that Microsoft has violated the antitrust laws" in the SCO situation, he said.

First Amendment freedoms permit monopolists to sue competitors or fund others to do so, as long as the suit isn't baseless, said Mike McNeely, an antitrust attorney in Gray Cary's Washington, D.C., office. And the Microsoft settlement is mostly about disclosing interfaces to Windows and to some Microsoft server software: "I don't see anything in that (settlement) that relates to the issues SCO is raising," McNeely said.

Is SCO's claim baseless? Is SCO's claim baseless?
One can debate whether SCO's suit against IBM is credible, but it didn't spring from thin air. Some of the motivation dates back to the days when the company was called Caldera International, still sold a Linux product and had just completed acquiring its Unix intellectual property from the Santa Cruz Operation, a company that renamed itself Tarantella.

Through a collaboration called Project Monterey, the Santa Cruz Operation and IBM worked to develop a version of Unix for Intel's Itanium chip family. The software used IBM's version of Unix, AIX, at its heart but also included the Santa Cruz Operation technology, and the agreement called for IBM to pay royalties for its use.

That expected royalty stream was "one of the major reasons why we bought the asset," Ransom Love, Caldera's CEO at the time, said of the Unix purchase from the Santa Cruz Operation. But Love claimed that IBM then stiffed Caldera: First, it appended the AIX label to the Monterey product, much to the disappointment of resellers and IBM rivals such as Compaq Computer that weren't interested in an IBM-branded OS; and then it canceled its Monterey products outright--in favor of Linux--depriving Caldera of royalties.

When Caldera called a meeting to object, IBM made a "pathetic" offering of compensation, Love said. "They thumbed their nose, and said, 'Oh well.' They offered something like $50,000 or some ridiculous amount for settlement." Caldera couldn't afford to risk suing a major partner, so it instead chose to collaborate on Linux with IBM. "When you deal with these elephants in the industry, you kind of take both ends of them," Love said.

"In many cases that means our suppliers have backed down (from Linux) because they didn't feel comfortable on that indemnification issue."
--Tony Scott
CIO, General Motors
But IBM's support of Linux shouldn't have come as a surprise. Caldera and IBM both were members in 1999 of a separate project called "Trillian" to bring Linux to Itanium. After beginning sales partnerships with Linux sellers and investing in Red Hat in 1999, IBM trumpeted a $1 billion investment in Linux in 2000.

Regardless, Monterey now figures in SCO's lawsuit--specifically, SCO's argument that "IBM misappropriated the confidential and proprietary information from SCO in Project Monterey." That dovetails with a central SCO claim, that IBM moved SCO's Unix intellectual property to Linux against the terms of its Unix contract with SCO. IBM denied that and much of SCO's Monterey description in its legal filings.

Legal or not, don't Microsoft's activities involving SCO show how desperate Microsoft is to combat the rising adoption of Linux?
Yes. And if you think Microsoft doesn't play a particularly brutal brand of hardball, check in with Apple Computer, IBM, Netscape, Novell, Stac Electronics, Slate, Sony, RealNetworks and Lotus.

In the case of Linux, the OS is becoming a staple in the corporate computing diet--an outcome that Ballmer has called a key competitive challenge.

Is Microsoft's involvement reaping dividends for SCO?
Yes and no. SCO's bottom line hasn't firmed up, and its plan to sell intellectual-property licenses has largely failed so far, but some clouds of doubt are circulating over Linux.

For example, the SCO case has made the cautious stances of some companies, such as General Motors, seem less unusual. Though GM doesn't buy computing technology directly, instead contracting with others to install and run its systems, it does exercise some control that indirectly has kept Linux at arm's length.

"Where we've had a Linux proposal, we have not backed down from our requirement that there be an intellectual-property indemnification across the board for everything used to provide a solution for GM," Chief Information Officer Tony Scott said in an interview. "In many cases that means our suppliers have backed down (from Linux) because they didn't feel comfortable on that indemnification issue."

SCO's actions continue to generate ripples, if not profits, for SCO. Linux founder Linus Torvalds, while widely disparaging SCO's actions, has instituted a procedure to track Linux source code contributions. At the same time, start-ups Black Duck Software and Open Source Risk Management are trying to profit from the new attention devoted to open-source software and intellectual-property risks.

Hasn't the impact been fairly limited, considering that Linux continues to make inroads? Hasn't the impact been fairly limited, considering that Linux continues to make inroads?
Despite some corporate caution, Linux still has strong momentum.

For one thing, major companies such as Intel still contribute new software to Linux, and development of new Linux versions continues unabated. Few have paid SCO the $699 per single-processor Linux server the company is demanding for a SCO intellectual-property license that wards off litigation.

And Linux hasn't stopped proliferating--indeed, Linux server sales grew 62 percent to $960 million in the fourth quarter of 2003 as Linux spread to higher-end machines, according to IDC. Also, a JupiterMedia survey found that 21 percent of U.S. companies with revenue above $50 million and more than 1,000 employees are using Linux on desktop computers--Microsoft's stronghold.

Isn't Microsoft's involvement in the SCO situation part of a pattern of behavior toward Linux?
It certainly doesn't seem to be just a coincidence. At the same time Microsoft was talking to SCO and winding down its antitrust litigation, it was gradually ratcheting up its response to Linux.

Microsoft initially attacked Linux and some other open-source software as a "cancer," as viral or as "an intellectual-property destroyer"--an effort that backfired. These days, it's using more pragmatic tactics, said Directions on Microsoft analyst Rob Helm.

"They've gone from attacking the open-source business model and development model to trying to co-opt the open-source development model."
--Rob Helm, analyst
Directions on Microsoft
Now, instead of churning out philosophical criticism, Microsoft raises questions about the expense of running Linux systems, via underwritten studies and advertising. As recently as October, CEO Steve Ballmer issued a 2,600-word memo that was almost exclusively devoted to knocking Linux. On another front, Microsoft is now launching its own open-source projects.

"They've gone from attacking the open-source business model and development model to trying to co-opt the open-source development model," Helm said. Microsoft also has countered with lower-priced Windows versions in markets where Linux has made inroads. "Microsoft is getting a handle on Linux," he said.

When considering motive, isn't Linux such a threat to Microsoft that an attempt to kill the OS would be considered self-defense?
It's certainly true that Microsoft emerged largely unscathed from the U.S. government's antitrust case--it wasn't broken in two and it's largely allowed to freely integrate new features into Windows--but it's had more trouble taking on Linux, which presents a different type of challenge compared with traditional rivals such as WordPerfect, for example, or Netscape's Navigator browser.

Linux's open-source foundation has provided a mechanism that has encouraged competitors to cooperate at Microsoft's expense. Linux's mutability let companies adapt it for new uses, expanding Linux's utility in the process. Corporate coders have joined the original band of volunteers working on Linux--but individuals still can make a difference contributing their code or launching their own projects. And today's engaged programmers become tomorrow's corporate computing staff, a lesson Microsoft knows well.

Active Linux support comes not just from overt advocates such as Red Hat, Novell and IBM but also from companies as diverse as Wind River, which makes software for embedded computing gadgets such as nerve gas detectors; Oracle, which sells high-end database software; Motorola, which manufactures cell phones; and Linux Networx, which makes supercomputers.

And internationally, Linux has special appeal because of its adaptability and built-in independence. The world's two most populous nations, China and India, are embracing Linux at the same time that Microsoft is having trouble in the developing world. And according to a November 2003 report by the World Bank, Thailand aims to use Linux for half its government computers.

And what's been the impact on SCO? And what's been the impact on SCO?
Despite the investment, SCO's fuel gauge is sliding toward empty.

The legal action pushed SCO's stock from less than $3 to a peak of $22.29 last November, but it hasn't fared so well since. The shares closed at $3.45 on Friday, giving the company a market capitalization of $57 million.

SCOsource brought in $678,000 in the second quarter but cost the company $7.4 million in legal and other expenses. SCO had expected the program to generate more revenue in the future, but it now acknowledges that SCOsource hasn't met expectations.

BayStar and RBC provided a major boost to SCO's bank account, but Microsoft and Sun Microsystems--which extended its Unix contract in early 2003--arrived during a clutch moment. According to SEC filings, Microsoft and Sun provided nearly a third of SCO's $79.3 million fiscal 2003 revenue--$16.6 million from Microsoft and $9.5 million from Sun.

At the time, SCO's financial reserves were dwindling. Cash and marketable securities dropped from $9.6 million on July 31, 2002, to $8 million on Oct. 31, 2002, then to $4.9 million on Jan. 31, 2003. When SCOsource payments from Microsoft and Sun started rolling in by the end of April, cash perked up to $10 million--just in the nick of time, since operating expenses that quarter were $11.3 million.

Is SCO a technology company or a litigation shop?
The company still sells its Unix products, but they aren't widely used, and several legal experts believe the company can't withstand a legal loss.

"You have a big company beating up on a little company. You put that up in front of 12 people in Salt Lake City a year from now, and we like the outcome of that."
--Darl McBride
CEO, SCO
Technology played second fiddle to intellectual-property enforcement in the quarter ended July 31, when SCO spent $2.5 million on research and development compared with the $7.4 million for SCOsource.

And SCOsource spending isn't tapering down. In March, McBride said SCO has "a budget now where we spend $2 million to $3 million a quarter on SCOsource, with an upside measured in the billions. We're halfway through (the schedule) right now. If it takes another year, you're talking about an $8 million to $12 million investment."

But in June, McBride said SCO is going through its money faster, budgeting $3 million to $5 million per quarter for SCOsource. Even that rate was well under the $7.4 million the company actually spent by the end of July.

SCO's agreement with its lawyers now protects its cash balance--though Decatur Jones analyst Dion Cornett estimates the company has only $8 million that's not earmarked for legal expenses.

In the end, though, SCO thinks it has what it takes to prevail.

"We think, and from talking to Boies, he thinks our case is one aligned nicely for jury trial," McBride said. "You have a big company beating up on a little company. You put that up in front of 12 people in Salt Lake City a year from now, and we like the outcome of that."

Topic: Software

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