December 10, 1999
A Tiny Company With Dim Prospects Goes Public With a Bang
By LAWRENCE M. FISHER
AN FRANCISCO -- Internet
mania reached new levels of frenzy Thursday
as investors paid huge multiples on an
initial public offering, giving a market value of almost $10 billion to a tiny company
with powerful competitors, little revenue
and no expectation of earnings in the foreseeable future.
The company, VA Linux Systems of Sunnyvale, Calif., sells computers powered by
standard Intel Pentium processors that
run on Linux, the free Unix-based operating system created by a Finnish graduate
student and now marketed by more than a
dozen companies worldwide. The computers are designed as servers, computers
that deliver Internet products, like Web
pages and e-mail, or other network services.
Though giants like Dell Computer and
I.B.M. already market Linux servers of
similar power, shares of VA Linux Systems
surged more than eightfold today, setting a
record for an initial public offering.
The company sold 4.4 million shares, an
11 percent stake, priced at $30 a share,
raising $132 million. The shares opened at
$300, and closed at $242.375 in Nasdaq
trading.
The appetite for shares of companies
that deal in Linux products and services
has been enormous this year, and those
stocks shared in today's largess. Shares in
Red Hat, a Linux distributor, have soared
20-fold since the company went public Aug.
11 and rose $16.50, to $287, today. Andover.Net, which runs a network of Web sites
devoted to Linux, has more than quadrupled since its initial offering on Wednesday,
gaining $14.8125, to close at $78.8125. The Corel
Corporation, which sells software that runs
on the Linux system, most notably a Linux
version of its WordPerfect document creation software, rose $11.25, to $39.375, after trading as low as $2 in the last year.
VA Linux has never made money and
does not expect to for some time.
As the
company's prospectus points out:
"We do not expect to generate sufficient revenues to achieve profitability and, therefore, we expect to continue to incur net losses for at least
the foreseeable future. If we do
achieve profitability, we may not be
able to sustain it."
No problem, said the stampeding
market.
"A stock like this is an obvious
example of something going through
the roof with absolutely no underlying fundamentals," said Michael C.
Perkins, co-author of "The Internet
Bubble" (Harper Business, 1999). "It
starts with the institutions flipping
the stock, and then the momentum
players and the day traders take
over. Just when you think you've
seen the peak of the insanity, this is a
perfect bubble stock."
Linux, created by Linus Torvalds
in 1991, has become a cause célèbre
within an industry wary of Microsoft's domination of both operating
systems, with Windows, and the business application programs that run
on it.
It is also the darling of "open
source" advocates. Open Source is
based on the concept that making a
program's underlying code freely
available, and allowing it to be modified by anyone, will result in a more
powerful and secure system and will
free consumers from the tyranny of
proprietary operating systems, especially Windows. Linux grew out of
the GNU Project, an effort to build a
free operating system similar to
Unix.
Although the Linux kernel and associated GNU (pronounced NEW)
components can be downloaded for
free by anybody, more than 22 companies now sell GNU/Linux software. The best known are Red Hat,
Suse, Turbo Linux, Caldera Systems
and Mandrake Soft.
As the notion that Linux could be a
viable alternative to Windows has
gained currency, these companies
have captured the imagination of investors.
In part, that notion was fed by
Microsoft itself, which insisted earlier this year in its antitrust battle
with the government that Linux
threatened its Windows monopoly.
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So much for making
money the old-
fashioned way.
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"People who were not there for the
great I.P.O. of the 80's see this as an
opportunity to ride the crest again,
as Microsoft II," said Maureen
O'Gara, publisher of Client Server
News, a trade publication. "This is
not based on fundamentals. They
don't read beyond the first page of
the prospectus."
In the case of VA Linux, she said,
"The fact that they could be crushed
by one finger of Dell's hand has not
slowed their flight."
Shipments of Linux-based computers are expected to grow by 25 percent from 1999 through 2003, more
than twice the 10 percent to 12 percent pace for other workstation and
server systems, according to the International Data Corporation, a market research firm based in Framingham, Mass.
But that kind of increase is possible only because the market today is
so minuscule. Lost in the excitement
about Linux is the fact that the actual
user base today is tiny compared
with Windows, commercial versions
of the Unix operating system or Apple Computer's Mac OS. Although
Linux proponents often say that the
operating system is more reliable
and secure than Windows NT, major
corporations have not been eager to
run mission-critical applications on
Linux.
Those that have embraced
Unix are more likely to purchase
Solaris from Sun Microsystems, HP/
UX from Hewlett-Packard or other
name brands.
VA Linux's biggest sales have
been to Internet companies, including Akamai Technologies, eToys,
StarMedia Network and 24/7 Media.
Sales to these four customers accounted for 14.5 percent of the company's total revenue of $17.7 million
in fiscal 1999 and 23.3 percent in the
first quarter of fiscal 2000.
"People say Linux is going to kill
Microsoft, but I say, 'How do you do
that without killing Sun first?' " said
Michael Murphy, editor of the California Technology Stock Letter. "I
don't think they have any understanding of what Linux is, what it
means, the fact that it's free."
Nevertheless, VA Linux was represented by leading investment
banks, and had previously attracted
savvy venture investors. Credit
Suisse First Boston was the lead
underwriter, with Deutsche Banc
Alex. Brown, Hambrecht & Quist and
Lehman Brothers as the co-managers of the offering. The company's
backers include the Silicon Valley
venture capital firm Sequoia Capital,
which holds a 23 percent stake, and
Intel, which holds an 8.9 percent
stake.