It was the hottest first day in Nasdaq history. On February 10, 1999, VA Linux Systems rose from its initial price of $30 to almost $220, a record-breaking first-day gain of 733 percent.
The meteoric rise of the stock seemed to take just about everyone by surprise, including VA Linux itself. Its chief executive Larry Augustine and board member Eric Raymond immediately got busy on the phone and in the media trying to talk it down. ‘It’s not that I don’t believe in the company or the ideas behind it,’ Raymond says, ‘but watching the stock rise to an unsustainable market value was more a proof of the herd instinct than anything else. Our biggest concern was that it would spike and then crash.’
Yet, like other companies whose fortunes are tied to the renegade Linux operating system, VA Linux has outperformed – with a few market corrections – all expectations. Of course, those expectations were mixed from the outset, Raymond says.
Indeed, despite the operating system’s growing presence in corporate computing and its stock market success, some market watchers wonder if it’s more sizzle than steak. Investors may be along for the ride for now, says David Sturtz, an analyst at Prudential Volpe in San Francisco, but they’re skeptical.
‘Linux does have a strong technological basis,’ Sturtz says. ‘At the same time, Linux stocks are significantly overvalued, like everything else of course. It’s a concept market. It’s a market that’s not concerned with value, but with a cool concept.’
Cool concept
That concept is open-source software. Anyone can download Linux from the internet for free and no single company controls its source code. For investors accustomed to traditional business models, it’s all a cause for wonder. But for Raymond, author of The Cathedral and the Bazaar and the open source movement’s principal evangelist and ideologue, it’s a validation. ‘It has occurred to me that this all might be a validation of my ideas,’ he says. ‘But then it also occurred to me that this world is nuts.’
Some on Wall Street might be inclined to agree, and Raymond concedes that open source can be a tough sell to the investment community. Indeed at first glance, the idea seems at odds with conventional business practice. Under the open source model, the developer lets everyone use his software without charge, and provides open access to its source code, or software DNA. In effect, open source is about giving away the family jewels.
Moreover, anyone can repackage and redistribute open source software, and anyone can modify the source code to tailor the original program to their own requirements. The catch, however, is that open source licenses specify that all derived works of open source software must be made open source as well, thus perpetuating the process.
‘It’s the science model as opposed to the biotechnology model,’ says John Bickle, director of network operations for Generation.Net, a Montreal-based electronic commerce developer and internet service provider. ‘Unlike proprietary software, open source products are open to peer review. And, as a result, they have a flexibility and adaptability that proprietary products simply cannot match.’
That flexibility comes from being able to rely on a broad-based, voluntary pool of expertise to improve and upgrade products as requirements change and problems arise. One of Linux’s biggest attractions for corporate IT users, says Bill Claybrook, an analyst with Boston-based Aberdeen Research, is that it evolves organically out of the user-base itself. ‘You don’t have to wait for Microsoft to decide to publish an upgrade every few years,’ he says.
Control question
The fact that Linux isn’t actually controlled by any one company is its own attraction, Raymond says. ‘The truth is that if your critical business processes are being executed by software controlled by a proprietary vendor, then you’re at the wrong end of a monopoly and getting screwed,’ he says. ‘As far as I can tell, most companies like having control over their own business.’
That philosophy makes perfect sense to corporate IT managers and computer users. The big, established computer companies like IBM and Hewlett Packard, are solidly behind Linux because their customers want it and because, as an open source technology, they can use it without spending a penny on development, Claybrook says.
But even the leading Linux companies say they are always fighting the investment community’s skepticism and have to make the case for open source over and over again.
‘Every time we have a meeting on Wall Street, that’s a major topic,’ says Red Hat president Matt Szulik. ‘We had a lot of things in place that challenged the skepticism before the IPO. We were profitable, dominant in the market and we’d had a few rounds of venture financing. But we’re also a company that has a new idea of property that challenges traditional views.’
The big question the Linux companies have to answer is how do you make a profit on a free product. ‘That’s the $64,000 question,’ says Cliff Miller, chief executive of TurboLinux, a San Francisco-based company that hopes to go for a full public listing this year. ‘If you’re Red Hat, you plan to make it on services and support. But that is where we see a significant difference in business models. What we do is bundle and integrate a lot of commercial software with our operating system. And that’s what creates the value.’
That’s in line with Raymond’s contention in The Cathedral and the Bazaar, that software source code isn’t these companies’ main asset at all. Rather, he enumerates a number of open source business plans, each one based on using the software as a means to provide value-added products and services.
Numbers game
‘The general public and the investment community seem to believe that Linux is Linux,’ says Benoy Tamang, vice president marketing for Caldera Systems in Orem, Utah. Caldera filed its IPO registration papers in January, and has gone to great pains to differentiate its product pitch. ‘Once they understand the business focus and they figure out that each physical implementation of Linux is different, then they get our value proposition.’
Nevertheless, all the main Linux companies put a great deal of effort into promoting Linux as a whole and the open source philosophy it’s based on. Indeed, open source evangelism remains a major point in VA Linux’s IR effort, Raymond says.
‘It’s a mission,’ he comments. ‘I’ve been spending a lot of time at conferences where Wall Street types hang out. I’ve been targeting a certain stratum of Wall Street for the simple reason that that’s where the money and the leverage are.’
It’s also a numbers game. By promoting the idea of open source to the investment community, Raymond not only benefits VA Linux, but helps to encourage investment in other Linux-based companies. And as much as they all need, or want, investment, the Linux companies also need a mass market so that they can make their case for investment.
‘Most of their business models are based on flooding the market, so it’s a good thing their core products are free,’ Claybrook says. ‘If VA Linux is selling computers specially designed for the operating system, and Red Hat is selling support, then you need a whole lot of people to make money. And no-one’s going to continue to buy your stock for long if you’re not making money.’
Indeed, Linux’s rapid growth in the computer market – first released in 1991, it now has over 20 million users – has taken on the character of a crusade. Linux users form a tightly-knit internet community and many are as likely to invest in Linux companies as they are to use the operating system. In fact Will Roseman, co-chair of the Linux Fund, a New York-based investment group, observes that Linux companies seem to have a higher than usual proportion of individual investors, many of whom are also Linux users.
‘You see an awful lot of open source individuals buying into these companies,’ says Roseman. ‘In fact, we’ve been amazed by the number of people who come to our business through the web – almost half of the people who come to our site ask us how they can invest. There are a lot of people out there who are really excited about Linux and, of course, they also want to be part of it.’
Hackers as investors
It’s an investment market that every Linux company should be interested in, and most of them have significant investor relations efforts in the area, says Roseman’s partner Frederick Berenstein. The problem is that the hacker-driven, internet-based Linux community is not always quite compatible with Wall Street.
That point was emphatically driven home last year when Red Hat announced that it would hold back a portion of stock for a special issue to Linux and open source programmers. The company said that it was giving something back to the community upon which it was built, but the offer created more bad feelings than good will.
When the programmers lined up at E-trade to get their piece of the Red Hat IPO action, they were in for something of a rude surprise. Few met the online brokerage’s trading qualifications and were turned away. It was the first manifestation of a clash between the two opposing cultures of open source and Wall Street, but with more Linux companies gearing up to go public, Raymond doubts it will be the last. ‘There’s definitely some tension there,’ he says. ‘It’s a question of what kind of social machine you’re part of.’
Nevertheless, Raymond believes that the investment community will have to adapt to the open source movement rather than the other way around. He is quick to point out that the open source philosophy has driven many – he would say most – of the computer revolution’s innovations. And Raymond sees this as the chief motivating force for innovations that are yet to come. Indeed, he argues, the investment community should not look upon open source as a radical step, but see it more as a return to the spirit that, once upon a time, created the internet.
‘As an industry, I think that we took a wrong turn about 30 years ago, and got stuck,’ he considers. ‘It wasn’t so much that there has been opposition to open source all this time, but that it required some critical conditions. Now, of course, we have the internet and a mass market for technology. There is a threshold in transaction costs that either keeps technologies closed, or if it’s low enough, favours open source. In this case, the threshold is low, and we’ve crossed it.’
In effect, open source is an idea whose time has now come. The proof, Raymond says, is how well open source technologies are expanding their share of the software and computer markets and how well Linux stocks continue to perform.
Open source has made a successful pitch to investors. How far they’re ready to buy into it, though, is anyone’s guess. ‘Does Wall Street accept open source?’ Raymond asks. ‘That’s a little like being in 1920 and asking if it will accept the automobile.’
