Wednesday, December 31, 2008

Red Hat (RHT) Thrives During Recession

Red Hat (RHT), the open source Linux and middleware company, reported a very good quarter (3rd fiscal quarter ending November 30, 2008) on December 22, 2008. I've written extensively on Red Hat (See my Red Hat page) as a company whose time has come. With a 22% revenue increase since the similar quarter last year, it is doing what many other technology companies said they would do during a recession.

The basic tech stock pitch from management in 2008 was "My company's products offer a high return on investment, so if anything a recession will increase our sales as our customers seek to cut costs." As 2008 progressed more and more companies that took this line saw their sales slow or even go into reverse.

Red Hat has a solid base of subscribers who use its Red Hat Enterprise Linux (RHEL). It now has a strong middleware offering in JBoss. It costs a lot less to run a server farm on RHEL than on UNIX or Windows Server operating systems. Not every enterprise is in a position to switch every day, but every year since the 2001 tech crash Red Hat has gained substantial ground. Early investors in Red Hat, including those who bought at IPO prices, got burned, but buying at 2003 or later prices has worked out well for investors.

Guidance for fiscal Q4 ending February 28, 2009 is for only a slight increase in revenue. Fortunately Red Hat is already profitable on a GAAP, non-GAAP, and cash flow basis at this level. Management seems to understand that being a value proposition company, they should keep their own expenses down. General and administrative expense for the quarter was $24.8 million, or 15% of revenues of $165.3 million. R&D expense, while substantial, is somewhat alleviated by the open source nature of the Linux project.

Red Hat offers products that are of proprietary quality (some would argue they are better than products from companies like Microsoft, Oracle, and SAS) at prices that are substantially lower than their rivals. I know, because I have experienced, the foot-dragging nature of institutional technological change. When all you know is Windows, and you have paid for a lot of proprietary software or programming to work with it, switching to Linux is daunting. There are some advantages to Windows programming; Microsoft Visual Studio makes application-level programming relatively easy. But at the enterprise level paying for Windows licenses can really add up. So I see no reason for Red Hat not to continue to get traction in the enterprise market.

A new area for Red Hat is the MRG platform, which has already begun to sell. MRG ("merge") integrates real time, messaging, and grid technologies. Red Hat claims it can run enterprise level computing 100 times faster (though they don't say than what).

For more on Red Hat's Q3 see my summary of the 12/22/2008 Red Hat Analyst Conference.

See also:
open source software

Wednesday, December 17, 2008

Adobe (ADBE) CS4 Failure to Launch?

Adobe (ADBE) at its analyst conference yesterday reported that fiscal Q4 2008 revenues were barely above those of the year-earlier quarter. Profits increased due to cost cutting.

While other segments increased sales year-over-year, flagship Creative Suite 4, or CS4, revenues were down 11% from year-earlier. Management also commented that compared to the launch of CS3, sales were running 20% slower. Management claimed that this was entirely due to the poor external economy. During the question and answer period several analysts asked if CS4 sales might be lagging because it is not a compelling upgrade to CS3. Management insisted that it is the best productivity enhancer since the invention of computer graphics, that everyone loves CS4, they just are slow to upgrade because of the cost.

Management is probably right on this. There really aren't any good alternatives for professional graphics people. People hate the high price of Adobe products, and they hate being squeezed by the upgrade cycle, but they hate being at a professional disadvantage to those who have upgraded even more. If there is any problem for CS4, it is that in a recession a large number of graphics and Web designers will lose their jobs or their clients. With the newspaper industry threatening to disappear in its entirety, and CS4 making the remaining graphics humans so much more productive, it could be that the CS4 client base will shrink permanently.

Future growth may come from the numerous other Adobe web initiatives. This is a company that knows how to innovate and squeeze money out of its customers (I point that out only because so many highly innovative technology companies lately have not been able to figure out how to make their customers pay for innovation). Case to point is video delivery over the Internet. A few years ago this was done mainly through Apple and Microsoft products. Now it is mainly done with Adobe Flash.

I agree with management that when this recession is over, Adobe will do better, but then I could say that of every company in the world right now.

For a full report on the financials, see my Adobe analyst conference summary for fiscal Q4 2008.

I don't own stock in Adobe. I do use Adobe products. I sometimes work for Adobe competitors and in the past have worked on books about Adobe products.

More data:

Tuesday, December 16, 2008

Anesiva's Good Adlea Results

I trashed Anesiva management for not keeping investors informed of its problems with manufacturing Zingo [See Anesiva (ANSV) Drops Zingo].

Yet I felt the market reaction to the discontinuance of Zingo was overdone. Why? Because the majority of the future value of the company was always in the potential of Adlea.

Adlea a simple, long-term painkiller that is dripped into surgical wounds. It appears to have no side affects and keeps pain down for weeks. It allows patients to cut back on their use of morphine. The FDA is reputed to be eager to have a non-addictive, surgical wound specific analgesic on the market.

Adlea has had a lot of clinical trials now, including Phase III trials. Overall it has done well, always showing pain reduction, but in some specific uses or test runs not quite hitting its endpoints. The latest test results [See Anesiva Adlea press release] met the endpoints for total knee replacement surgery.

Adlea's problem now is that they ran through their cash after they got FDA approval for Zingo. So they don't appear to have the cash required to get Adlea to market. They need a partner, because in this market you can't issue new stocks or bonds even if you have a blockbuster winner like Adlea sitting in your lap. Another possibility would be a buyout from a larger pharma company.

Sometimes other companies are willing to let a winner die on the vine, either to prevent competition or to pick it up even cheaper later. There's no telling how this would play out. Normally I'd say Anesiva (ANSV) is worth large multiples of its current market capitalization, but that depends on money coming from somewhere to get Adlea approved and marketed.


My Anesiva page

Keep Diversified!

Friday, December 12, 2008

California Housing Dynamics

At this point I am largely discounting the Great Depression scenario. It is not impossible, but its probability has receded to the extent that I believe it is better to focus my analysis on less grim pictures.

I even doubt the recession will last into 2010. A lot of this has to do with housing.

Right now mortgage rates (standard 30 year rates) are moving towards 4.5% interest. Unless you already own a house, it is foolish to pass by what may be a once-in-a-lifetime opportunity. In California, in some areas, houses can be bought for less than they were priced at before the bubble began in 2002. Even desirable San Francisco neighborhoods are off their peaks. Many new and nearly new homes are available at bargain prices as well.

Why are people not buying, at least not in sufficient numbers yet to prevent price declines? Fear in an auction market. Few people want to buy an asset with a declining trend line. Most people think in straight lines, not in cycles. They don't want to guess at turning points.

We know there will be a turning point, in California and elsewhere. Once housing prices start back up, pent up demand from immigrants, the houseless, and the braver sort of speculators will turn into actual buying. At first this will drive houses to what would be their equilibrium price in a non-auction system, basically somewhere between the cost of building or replacing the house and the rental equivalent.

Getting to the turning point will require stages. We have already completed, or nearly completed, the first stage: a dramatic drop in house sale prices to below their equilibrium value.

With 4.5% mortgages we will get the next tranche of buyers, those who can put rationality ahead of their fears. They are going to get serious bargains. They will worry that houses or interest rates will go lower, but that will be offset by the desire to get into the house they want, before choices get narrowed.

Meanwhile, the employment situation in the real estate industry will improve slightly. Not too many houses are being built, and less are being started, in California right now. Brokers and realtors will get some wind in their sales from the first tranche of buyers, and the most optimistic builders will start making plans just in case their inventories start to sell.

When prices clearly stop going down, a lot of fence sitters will jump in. At first this will absorb inventory rather than raise prices significantly, but again it will result in increased employment in real estate, and maybe even at building supply and furnishings retailers.

We will know we are on to the third tranche of buyers when people start seeing their favorite potential homes picked off by someone else. The word will be out: buy now while interest rates are low, prices are low, and there are a lot of choices.

Then prices will start rising. You know the rest of the cycle. Builders will have lagged with new home starts, so by the time inventory is getting to normal levels they'll be in a panic to start up again. Lots of people will get hired. For a while the porridge will be just right, and then, lessons of the past forgotten, the porridge will get too hot.

It is a great time to move to California. I heard in 2005 people wanted to move here but could believe the housing prices. In some places today, in the central valley, houses are at midwestern prices.

But I am not thinking of getting into speculating in housing. While the leverage advantages are good there, I think stocks are even more undervalued than homes right now. I already own a home, but I don't own anywhere near enough stocks or bonds (but it is a bad time to buy bonds) yet.

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.

Wednesday, December 3, 2008

Can Marvell Smash the Atom?

Marvell Technology Group (MRVL) stock is way up today partly because investors had been overly pessimistic about its results for the October quarter (its fiscal third quarter of 2009). But the big news is that Marvel is going into the Netbook market. Which means competing with the Intel Atom processor. This is really cool. This is really exciting for investors, consumers, and gadget freaks.

Despite revenues that dropped to $791.0 million from $842.6 million in the 2nd quarter, Marvel kept its Net income high at $71 million and its free cash flow amazingly high at $246 million. For a in-depth summary of the results and what management said see my Marvell Analyst Conference Summary for December 2, 2008.

The Netbook market could be called the sub-notebook PC market. Netbooks don't have the full-powered Intel or AMD Turion processors or graphics capabilities of notebook computers, but they are cheaper. They are designed mainly to run a Web browser and do e-mail. I've seen a lot of false advertising recently, with one ad describing the Intel Atom processor in a netbook as "powerful."

But when you think about building a good Netbook from the ground up, any smart engineer would say, why Microsoft Windows for the operating system, and why Intel Atom for the processor. The only answer is that they are what people are used to. On the other hand consider a netbook not as a smaller PC, but as a larger smart phone. Suddenly there are many hardware and software choices, some of them found in devices like the Apple iPhone or the Blackberry Bold. And what you will find in many of these devices is Marvell semiconductor chips. And non-Microsoft operating systems like Linux.

Normally going up against Microsoft and Intel, even if you have better products, is not a very good business strategy. Intel in particular, in its competition with AMD, has shown a willingness to use heavy-handed tactics to maintain and extend its market share. Even its ability to subsidize advertisements for its products when people open catalogs or Web merchant sites insures that the playing field is not even. Should investors cheer Marvel tilting up against Intel?

The outcome is in doubt, so hedge your bets. But there is good reason to believe Marvell will at least carve out some good profitable market share, aside from their history of consistently entering new fields and turning the fields.

Marvell already has most of the intellectual property in place to build a single chip that can run the entire netbook. Netbook manufacturers will supply the display, case, and connectors; one chip shall rule them all. The cost will be far lower than Intel can compete with profitably. Intel will probably try to differentiate its products by saying they run Windows, but the reality is they don't really run Windows in the sense that a dual-core notebook processor runs Windows.

If you have not been following Marvell, you may not know what they already do. They specialize in combining digital and analog circuitry in a single chip. They got started by supplying chips that make hard drives capable of storing more data faster. They now dominate the drive chip industry. They branched out to a number of areas, including chips for printers. They also bought Intel's old XScale cell phone processor division, which I believe the Intel guys are going to be kicking themselves over in about October, 2009. Intel was losing money on the division, Marvell is making money.

Marvell also makes superfast chips for physical and wireless internet connections. They make video chips for DVD players and large screen TVs. Their Sheeva processor, combining technologies from ARM, XScale, and in house, runs super fast on super low amounts of power.

By building a netbook from the bottom up, based on a processor that is ultra-green because it was meant to run cell phones, incorporating all the necessary circuits on a single chip, Marvell will enable netbook manufacturers to sell their products for well under $300. Marvell says $200, then $100 is possible.

Will people mind not being able to run Windows? Some people will, but the Netbooks can't run the really cool Windows stuff, like games and Adobe design products. What Linux enables for netbooks is the ability to do email and Web browsing, plus low-overhead tasks designed for the netbook. The competitive advantage of open-source software running on Linux will really shine on a netbook.

With a Sheeva processor from Marvell running applications much faster than an Atom processor, and consuming far less power, it may be hard to keep the Win-tel team alive in this particular market. AMD's decision to stick to notebooks, where its graphics superiority over Intel gives it an advantage, may be just the right thing to do.

Of course, this is speculation about the future. Marvell is the David in this battle. But I have seen Marvell's slingshot, and I would not want to bet on the Goliath, Intel, in this market, even thought it dominates the field at the moment.

It should be noted that Marvell believes the netbooks based on the Marvell chip will open up the Internet to a new global market of between 1 and 2 billion people. Based on what I know about global income demographics, that sounds about right.

As always, keep diversified.