Will Wall Street's Linux love affair last?

The formula for Wall Street success in recent weeks is simple: Latch on to Linux and watch your stock soar. But is the bubble bound to burst?
Written by Larry Barrett, Contributor on

Investors went bonkers Tuesday as V-One jumped 279 percent after it started shipping a product that supports the much-hyped Linux operating system. V-One's ascent illustrates how desperately investors want to be part of a "buzz" on Wall Street regardless of the peril.

The formula for Wall Street success in recent weeks is simple: Latch on to Linux or Red Hat, issue a press release and watch your stock soar. But analysts said the Linux euphoria has all the makings of a bubble that's bound to burst.

V-One is just the latest beneficiary the Linux craze. It and Red Hat have both seen a dramatic jump in their stock prices of late even though analysts following these companies readily admit their valuations are farcical.

While consumers and corporations clearly want an alternative to Microsoft ubiquitous Windows platform, the incredible surge in Red Hat shares since its August initial public offering has analysts scratching their heads.

"These valuations are patently absurd," said Bill Schaff, a portfolio manager at Bay Isle Financial in San Francisco. "There's a tremendous speculation fervour surrounding all these Linux-related stocks. There might be some legitimacy to what a company like Red Hat offers, but not at these prices."

The Red Hat madness hit its apex Monday when it traded as high as $254 (£152) a share, up from its offering price of $14 a share. It did slip back 26 5/8 Tuesday to 210, but that was more a case of a general pullback in the market than a sign that investors are ready to let this story go. Shares had a nice rebound Wednesday.

Keep in mind, Linux is an open source operating system that allows developers to make suggestions and amendments to the code. No one owns it, despite the proprietary tone that Red Hat officials have taken in recent weeks.

Essentially, Red Hat is a service company, an incredibly overvalued one, that may or may not be able to provide enhanced features for a system that still hasn't exactly set the world on fire.

Worse, there are virtually no barriers to competition so what you have is a company that's distributing a free and constantly evolving operating system that holds a very tenuous head start on the rest of the field. And the Linux field is about to get more crowded as VA Linux Systems and Caldera Systems have IPOs on deck.

"In this market, it's the first mover that gets all the attention," Schaff said. "What Red Hat offers is real, but it's still very early in the game."

In its latest quarter, Red Hat reported a net loss of $3.1m, or 9 cents a share, on sales of $4.4m.

V-One's stock was trading at 1 11/16 in early November before rocketing up to a close of 13 1/2 Tuesday after it announced a virtual private network product that supports both the Windows CE and Linux operating systems. V-One shares retreated on Wednesday, but are still well above their lows.

What V-One didn't tell the people who bought in at $5 a share or $8 a share or later at $12 a share was that this product should have been on the market two quarters ago. A series of managerial missteps and development delays combined with the exodus of its entire sales team this summer puts a bit of a tarnish on this supposedly significant announcement.

With only 17 million shares outstanding, more than 59 million shares of V-One changed hands Tuesday. But simply having the word Linux in its press release was enough to send its shares through the roof.

"V-One's got a lot of issues," said Elan Danon, an analyst at LaSalle Street Capital Markets, said Tuesday. "It's a very speculative play. Momentum players want anything associated with Linux right now. In truth, this is a $3 stock at the most."

And that's coming from an analyst who follows the company on a day-to-day basis and maintains a "speculative buy" on the stock. "They've got good technology but I'm giving them another two quarters to get their act together," Danon said. "Once the chat rooms get tired of pumping this stock, they'll move on."

On Wednesday, Damon claimed that ZDII had misquoted him or that his comments were taken out of context. What he meant was that V-One would only be trading around $3 a share if it weren't for all the daytraders blindly throwing money into the stock following its press release.

If anyone needs a reminder of what happens to stocks that jump on no-news press releases and unsubstantiated rumors, take a look back at the K-Tel International debacle of last year.

When a sector's hot, as the dot coms proved in April, anything and everything in the ballpark suddenly becomes attractive. Cobalt Networks, which makes server appliances for Web sites, shot up 12 5/16, or 8 percent, to an all-time high of 168 13/16 Tuesday after the four brokerage firms that underwrote its IPO initiated coverage of the stock with "buy" recommendations.

Goldman Sachs started Cobalt with a "market performer" rating while SoundView Technology Group started it with a "buy" rating and set a 12-month price target of $200 a share.

BancBoston Robertson Stephens analysts Dan Niles and Dane Lewis started it with a "buy" recommendation, saying they view Cobalt as a franchise name in the server appliance market for small to medium sized businesses, Internet service providers and workgroups of large corporations.

Cobalt is basically a hardware company, so what's the big deal? Cobalt uses the Red Hat Linux as its operating system. "We believe that Cobalt's product revenue will expand with the rapidly growing server appliance market," they said in a research note.

Even Corel, which fancies itself an underdog to Microsoft but has performed more like a dog with fleas in the past few years, has been getting a Linux buzz.

The Canadian software firm saw its stock jump 26 percent Monday after it shipped its WordPerfect Family Pack for home use. Those who thought WordPerfect was dead were surprised when it launched a desktop version of the popular Linux open-source operating system at the Comdex computer show in Las Vegas.

Folks, there's a reason Corel was a $2 stock in March and only a $5 stock in mid-October. Perhaps some investors believe that merely announcing that a product is available is tantamount to selling millions of units of said product.

You can bet there will be a half-dozen or more similar stories in the days and weeks to follow. After watching the mercurial rise in these companies' stocks, other fringe players -- perhaps the company that provides the janitorial service for Red Hat -- will start firing off their own Linux-laced press releases.

Maybe you're a believer. Maybe you think Linux will revolutionise the information technology universe. But when it comes to your investments, make sure you're not paying an Internet-stock premium for what amounts to an unproven services company.

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