Markets fall in love with Linux

There's nothing like a 1,500-percent-plus stock-value jump to catch the attention of investors.

Ever since Red Hat, a seller of Linux software, went public and rocketed skyward, investors have eagerly anticipated the growth of a hot new IPO sector. Two more Linux-oriented firms will go public this week -- VA Linux and Andover.net -- and plenty more are on the horizon. But what's the best way to play the rapidly evolving Linux market?

It's a foregone conclusion of most analysts and investors that both VA Linux and Andover.net will soar in the public markets.

"It appears the IPO players will have a huge windfall," says David Menlow, president of data firm IPO Financial Network in New Jersey. "It's only a question of how high these open ... As for VA Linux, this one is probably the best stock for the rest of the year."

Echoes IPO analyst Tom Taulli, "This is definitely a big Linux week."

Why the effusiveness?
Red Hat's (Nasdaq: RHAT) stock performance proved there is a huge appetite for shares related to Linux, the "open-source" operating system that was developed by a loosely organized network of programmers worldwide. That appetite only increased this fall when a federal judge ruled Microsoft Corp. (Nasdaq: MSFT), maker of the dominant operating system Windows, a monopoly and thus possibly subject to a wide range of new restrictions. (Microsoft is a partner in MSNBC.)

Two schools of thought have quickly emerged over the fate of Linux-oriented companies and stocks. One crowd, even at this early stage, considers the Linux arena to be an overheated niche that will quickly fill up and consolidate. A separate consensus believes the Linux field is endlessly large and evolving (just like Windows computing) and that there is vast room for a countless number of players.

"This is really a very early portion of the overall Linux movement," contends William Roseman, co-chairman of the Linux Fund, which has investments in about a dozen early-stage Linux-oriented companies. "I think you'll see considerably more investment. ... We haven't even reached the cusp of it yet."

VA Linux offers support
The two firms going public this week bear little relationship to one another -- other than the Linux affiliation.

VA Linux (whose name didn't even include the word Linux until recently) is a maker of computer servers. For the most part, according to Forrester Research analyst Matthew Nordan, the servers are "commodity" machines, much like the ones distributed by many other suppliers.

However, VA Linux ships its servers with Linux installed, and while it isn't alone in doing that, the company makes a point of offering extra customer support for Linux operation. VA Linux also makes desktop systems that use the renegade operating system, and it supports them as well.

Linux is particularly well-suited to Web-serving tasks, and the largest customers of VA Linux are companies employing Internet infrastructure, such as eToys, StarMedia Network and Akamai Technologies. With revenues of nearly $18 million in the latest fiscal year, VA Linux is backed by a strong team of financiers, including underwriter Credit Suisse First Boston.

Andover.net complications
Andover.net, by contrast, is an information portal. Intended to be the Yahoo! of the Linux world, Andover.net makes money mostly from advertising. Annual revenue is about $1.4 million, and the company employs roughly 50 people. With its recent acquisitions of the popular Slashdot.org and Freshmeat.net sites, the company believes it now commands about half the total Web audience seeking information and tools for Linux development.

Because Andover.net is partly a media play, some analysts aren't quite as hot on Andover as they are on VA Linux. And yet, no one predicts a flop.

There is one more twist, however. Andover.net's IPO will be handled as a Dutch auction, meaning, at least theoretically, that the price it fetches in the IPO will reflect the true demand for the stock. This system runs counter to the behavior of most Internet-stock offerings, in which relatively few shares are offered at a price often set below market, sending the share value soaring during early trading hours and days.

Many investors (and perhaps even more reporters) don't fully understand the Dutch auction system. ("I'm somewhat in the dark about some of the nuances," admits one IPO analyst.)

The misunderstanding has frustrated underwriter W.R. Hambrecht ("It's an ongoing education," laments a Hambrecht spokesperson) and it has led to misplaced disappointment in IPOs that don't jump substantially upon commencing.

Despite all that, most expect the Andover IPO to be a strong one. And they admit the reason is simply that Linux is white-hot in the investment world right now

Playing the Linux connection
To understand the Linux market dynamics, consider, for instance, the case of Corel Corp., the Canadian maker of WordPerfect and other software applications.

When Corel came out with a packaged version of Linux (the core code is available free), its shares skyrocketed. Still, the firm’s stock trades at about $15 a share, vs. about $6 a couple months ago.

Cobalt Networks, meanwhile, which makes single-function servers that happen to run on Linux, has risen more than 500 percent since its initial offering just last month.

Given that environment, it came as a surprise to no one that Andover.net just raised its expected initial stock-price range, to a maximum of $18, from $15 previously.

Despite the mounting momentum for anything Linux, Nordan, the Forrester analyst, believes the companies covered by that blanket will eventually be recognized as too diverse for such a treatment. Listing off the various companies, from the portal to the specialized-server maker, Nordan says: “You quickly see that these companies have virtually nothing in common. They just all like to play up the Linux connection.”