Tuesday, December 9, 2008

Novell and Microsoft: Risk Assessment

Open source advocates are unhappy with Novell because of its relationship with Microsoft regarding Linux licenses. Investors in Novell (NOVL) are not terribly happy with its track record these last few years, but the Microsoft relationship is seen as a plus. Should it be?

You can get a good picture of where Novell is financially from my summary of the Novell analyst conference of December 4, 2008. Let's say Novell tends to lose traction here while gaining traction there.

A couple of years ago Novell was a cash play. They had a lot of cash, but were losing money each quarter. Now the bulk of the cash is gone (the one billion that remains is healthy, but not enough to do cash buy backs safely in this climate). So investors need to look at the underlying business.

It isn't that Novell has not been trying hard, even undergoing a fundamental market transformation. The question is, was it the right transformation?

Novell used to be a specialist in local area network (LAN) software. But that was the sort of thing that Microsoft (and Apple, and Linux) could provide as part of the operating system. Novell, of course, featured up their offerings, but the decline in marketability was clear a decade ago and they never really did much about it until maybe 2005 or so.

Novell sold proprietary software, but I guess they could not find a proprietary area where they thought they could compete (or make an acquisition that made financial sense). So they dove into open source software, including Linux itself. Everyone admits their SUSE Linux is good. Novell's clients were happy with it, but the pricing is a problem. Open source software just can't be priced like proprietary software. Red Hat has proven that you can make money selling support expertise on Linux, but it took them over a decade to get to where they are now. There are a lot of Linux versions out there. When you go with a particular brand of Linux you are basically chosing how much support you are going to get.

Microsoft wants its customers who have mixed systems - Linux and Windows - to use Novell SUSE Linux. That makes life easier for Microsoft to support its customers. It also undercuts Red Hat, which is the greatest threat the Microsoft's lofty operating system profits.

Maybe Novell would like to be independent of Microsoft (see my Microsoft Analyst Conferences page), maybe they have some plan for weaning themselves away in the future. At present a big chunk of their revenues come from Microsoft. Three things could jeapardize this. Microsoft could release its own Linux - that would not be a big deal for Microsoft, though it would certainly raise some questions in the Linux community. Or Microsoft could switch partners. Or Microsoft could face a customer rebellion - we'll chose our Linux without your help, thank you.

In any of these scenarios Novell would be off on its own again as far as picking up Linux customers. Not a cheery thought.

Even so, the revenues that were booked for its Open Solutions segment were a mere $36 million in the quarter, of which $33 million was for Linux.

Workgroup revenue, which is the legacy business, was still the main money maker at $92 million for the quarter, down 6% from year-earlier. There are two other segments, Identity and Security Management with revenues of $37 million, and Systems and Resource Management, with revenues of $45 million. Service revenue was $34.6 million.

On the optimistic side, the variety of products is a safety feature, and only the Workgroup and Service segments had declining revenues. The acquisitions of Platespin and Managed Objects should help Novell keep close to the cutting edge in 2009.

I would like to see Novell do well, and am tempted to buy the stock at this price. But after watching it for years, I am not enthusiastic. Without the Microsoft deal Novell would have looked pathetic this last year and would not be a serious Linux contender. With the Microsoft deal, it looks pretty good, but with the dangers I stated above.

Which reminds me to keep diversified.

More data:

My Novell analyst conference summaries page

I own some Red Hat stock and do occasional freelance work for Microsoft. I use Microsoft Vista (which I think is great) for my client OS running on AMD chips and my outsourced web servers run on Linux.

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