Guild Companies--Novell Buys SuSE, Targets Linux Dominance

The industry has been wondering about Novell's intentions in the Linux operating system and middleware markets, and, yesterday, when it shelled out $210 million to acquire commercial Linux distributor SuSE, it made those intentions clear: it wants to dominate the Linux server and workstation market as it once dominated the file server market, with its venerable NetWare operating system. No more, no less.

Under the terms of the deal, Novell is paying SuSE's owners (it is privately held) $210 million in cash to acquire the entire company. IBM is ponying up $50 million in cash for preferred Novell stock to help SuSE and Novell support its eServer product line, giving it a 2 percent stake in Novell. Richard Seibt, CEO of SuSE, is being asked to stay on by Novell, which wants him to be its Linux evangelist. SuSE has 399 employees, most of whom will be joining Novell. Some overlapping administrative employees may be let go, but there is no overlap in the technical employees, according to the companies.

Many, if not most, Linux enthusiasts in the world will are happy about the Novell deal, since Linux needs many strong champions to stand against Windows. Novell, of course, does not want to put the SuSE acquisition in that context, and Chris Stone, vice chairman at Novell, said as much. "This is not about competing against Microsoft," he said in a conference call outlining the deal yesterday. "This is about reducing the impediments to the adoption of Linux in the enterprise." Well, yes. But that means competing against Microsoft, and it is clearly the case that by acquiring SuSE yesterday and Ximian last August, Novell has set itself up to be shot at by its old rival, which has been hacking away at the NetWare installed base for a decade with its Windows server products.

Look at the numbers. There are about 8 million Windows servers in the world, with perhaps as many as 100 million to 150 million users, compared with maybe 4 million NetWare servers and 80 million users. (Those NetWare numbers are a few years old, and the server count and seat count could have dropped some since that time.) These are still the two largest installed bases in the IT industry by server count. By seat count, I reckon that there are about 10,000 IBM mainframes with 20 million users, about 450,000 AS/400 and iSeries machines with 25 million users, and about 600,000 VAXes and AlphaServers with maybe 15 million to 20 million users worldwide.

Anyone who says that the SuSE acquisition does not resume the epic battle between Microsoft and Novell is either lying or stupid. Ditto for the relatively new struggle between Linux rival Red Hat and SuSE, now part of Novell. Red Hat went public in 1999, and probably signaled the apex of the dot-com boom, attaining a $20 billion market capitalization. As the stock market deflated, Red Hat has had deeper pockets than SuSE, but the tables have just turned on Red Hat now that SuSE is a part of Novell. To be sure, Novell has its challenges making money, having lost $144.6 million on $1.1 billion in sales in the past four quarters. But Novell knows a thing or two about IT customers, it has deep knowledge of software and services, it has $738 million in cash and equivalents in the bank, and, after its stocked rocketed up nearly 40 percent after the deal was announced, it has a market capitalization of $2.2 billion. Red Hat has been steadily growing its revenues and is now pulling in around $30 million a quarter in total sales a quarter, has been profitable in three of the past four quarters, has $306 million in cash and equivalents in the bank, and has a market cap of $2.5 billion after the Novell-SuSE announcement shaved 8 percent off. Life just got a lot harder for Red Hat, which doesn't have the kind of worldwide partner channel and support organization.

For this to work, Novell has to execute a business plan (rather than lose patience as it did with Unix, Borland, and some other acquisitions). It also has to avoid getting sued to death by The SCO Group, which could turn on it now that it is the dominant Linux provider. The funny bit is that Novell spun out Caldera Systems just as Linux was becoming known in the enterprise, and Caldera bought SCO for its Unix intellectual property and large Unix installed base. The Caldera-SCO combo is now The SCO Group, and it has sued IBM over Unix-Linux intellectual property issues. Novell could be next. Jack Messman, chairman and CEO of Novell, told the analysts and reporters on the call yesterday that the SCO issue was unimportant. "There is a lot of litigation around SCO. Novell continues to ask SCO to make public its claims, and we are not holding back because of SCO's unsubstantiated claims."

According to Messman, chairman and CEO of Novell, his company acquired SuSE because, in his opinion, it was the best commercial Linux in the market. While this may be true--Red Hat would certainly argue this--the fact is that SuSE is the one big Linux company that NetWare could buy and clearly rule. A combination of Novell and Red Hat would, in many ways, have to be viewed as a combination of equals because of their respective market capitalizations. Red Hat would have been a good fit, but SuSE is arguably a much better fit, particularly since it is a privately held company with not much hope of generating more than a few hundred million dollars of market cap if and when it went public.

With the SuSE acquisition, Novell is trying to transition from a proprietary operating system supplier to a big player in the open source community. Novell is porting its NetWare print and file services to the Red Hat and SuSE versions of Linux, so it was already well on its way to being a Linux player indirectly. (What will happen with Red Hat at this point is an unknown, but Novell is going to push its own full stack.) With SuSE, now Novell has its own Linux and will not have to rely on other Linux suppliers to endorse or push its NetWare 7 services instead of alternatives. (The future NetWare 7 will run on either a NetWare kernel or the Linux kernel.)

The SuSE deal also meshes well with the Ximian acquisition in August. Ximian, based in Boston, has about 70 programmers and managers, who were absorbed into the company as Novell Ximian Services. Miguel de Icaza, who was the chief technology officer at Ximian and led the Gnome project, has remained at Novell, and so has Nat Friedman, a cofounder of the company who is managing the Mono project. The Ximian team is also porting Novell's GroupWise middleware to Linux. The combination of the Ximian Desktop application suite and GroupWise on Linux desktops as a single, unified application will be a compelling alternative to Microsoft's offerings on Windows desktops, and the Novell-Linux stack on servers is a compelling alternative to Windows. What Novell does with its SuSE's Openexchange email and groupware server is a big question.

Novell's acquisition of SuSE is probably one of the coolest things to happen in IT this year, alongside the Intel Itanium 2 and the AMD Opteron. But never forget for a second that Microsoft has $50 billion in cash and its hoard grows by billions with each passing quarter because of its desktop monopoly and its increasing control of the server market. Microsoft is not going to like this deal one bit, and it will react accordingly. Brace yourself, Novell.

Novell expects that it will close the SuSE acquisition by the end of its first fiscal quarter, which ends January 31. The company said that deal would have no effect on its earnings per share in fiscal 2004, but that going forward it expected for the SuSE products to add to its bottom line. SuSE's initial contribution to Novell's top line will probably be small, considering that SuSE will only generate $35 million to $40 million in sales in calendar 2004. But this revenue could grow substantially over time as Novell and its channel push Linux with a vengeance.