Wall Street Beat: Ill winds for open source?

Red Hat and Novell woes raise the issue of whether IT investors are turning sour on open source.

Red Hat's woes this week raise the issue of whether IT investors are turning sour on open source. A somewhat disappointing forecast for the next quarter has investors fleeing, just as they have from the company's open-source rival, Novell.

A close analysis of the situation, however, may give savvy investors -- and open-source advocates -- courage. Red Hat's problems are probably more short-lived than Novell's.

Red Hat investors are rattled: Company shares (RHAT) have lost almost US$5 in value over the last week, closing Thursday at US$20.59, down US$0.38 for the day. On Tuesday, Red Hat reported solid second-quarter earnings per share of US$0.11, on revenue of US$99.7 million. This beat expectations of analysts polled by Thomson First Call, of EPS of US$0.10 on sales of US$97.5 million. The problem was the company's forecast for next quarter: revenue of US$103.5 million to US$105.0 million, compared with the consensus estimate of US$106 million.

Even before these numbers came out, analysts were questioning the company's ability to execute a smooth merger with Jboss. Up until recently, investors bought into Red Hat's strategy to move up the software stack. The Jboss acquisition gives it an application server. But disappointing cash flow suggest problems with executing this strategy, and even perhaps some push-back from customers.

Four different brokerages in the past month have downgraded their advice on Red Hat stock, with Soleil Securities Group recommending a "sell". But not all analysts are dour. Banc of America and UBS analysts, for example, have issued reports saying that Red Hat's problems are probably temporary, and that the company's strategy could still pay off with increased sales in the next few quarters.

Novell could face more long-term problems. The company has had trouble articulating a coherent strategy. And even though Novell sold its stake in Celerant Consulting to focus on core open-source software, stand-alone Linux sales for the company hover around just US$10 million.

But it's hard to analyze Novell's business using up-to-date figures, since the company postponed its quarterly report earlier this month, as it completes a voluntary internal review around the granting of stock options to employees. Novell may have to restate earnings. The delay in its earnings report caused the Nasdaq to issue a delisting notice. So far, Novell has been able to stay listed, by protesting the notice and requesting a review process.

The next few months should clarify issues around the two companies. Novell needs to get its internal review done, come out with earnings statements that analysts can rely on, and of course eventually show growth in new-software licenses.

Red Hat has fewer hurdles to jump. An uptick in cash flow should offer assurances that its strategy to offer a broader portfolio of tools and server software is on track.

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