The Linux Beacon--Citrix Buys Virtualization Challenger XenSource for $500 Million

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Volume 4, Number 30 -- August 21, 2007

Citrix Buys Virtualization Challenger XenSource for $500 Million

Published: August 21, 2007

by Timothy Prickett Morgan

Citrix Systems, a software provider that is best known for its access products that link remote users to central systems, stunned the IT market by acquiring the up-and-coming server and desktop virtualization vendor, XenSource, just a day after a chunk of rival virtualization juggernaut VMware was sold off in an initial public offering. The acquisition also follows the launch of XenEnterprise V4 last week, which is a credible alternative to VMware's Infrastructure 3 server virtualization tools.

XenSource is the commercial entity behind the open source Xen hypervisor created by Ian Pratt and other researchers at the University of Cambridge in England. XenSource was founded by Pratt basically because some people using the hypervisor he created as an alternative to other products on the market wanted to have commercial-grade support for the product. Since bursting on the scene four years ago, XenSource has created an open source hypervisor that is the only credible alternative to products from VMware--at least as far as data centers are concerned. This hypervisor includes a substantial amount of technology donated by server platform makers, who know a thing or two about virtualization. XenSource has also forged alliances with the two major Linux distributors, Red Hat and Novell, and has an alliance with Microsoft that will see the future "Viridian" hypervisor for Windows Server 2008 (formerly known as Longhorn Server) using virtualization formats that are compatible with the Xen hypervisor. With V4 of XenEnterprise, the company's flagship virtualization product for mixed Windows and Linux environments, XenSource has also forged an alliance with Symantec to use that company's Veritas Storage Foundation software to manage storage for the Xen hypervisor, giving XenSource another arrow in its quiver to compete against VMware, which has its own virtualization file formats and tools to manage these files.

The move by Citrix to buy XenSource is reminiscent of disk maker EMC's $635 million acquisition of VMware in December 2003. At the time, VMware was generating sales and poised to do its own IPO, but decided to be acquired by EMC instead. Ironically, here we are nearly four years later, and VMware is kinda doing an IPO as EMC has spun out a 10 percent stake in the company and sold two chunks to Intel and Cisco Systems.

While XenSource might be the only viable big player alternative to VMware at this point in the X64 server and PC virtualization, it is nowhere near as large in terms of sales and customer base as VMware was when EMC acquired it. XenSource has 200 paying customers and 350 resellers, and according to Citrix, the company will only add about $1 million in revenues in Citrix's fiscal 2007 once the deal goes through, and even then, it will account for $3 million in costs and operating expenses. So it is still losing money, and Citrix is paying a 500X multiple against sales to acquire XenSource. The ratio between VMware's 2006 sales of $706 million compared to its market capitalization is arguably ridiculous at a factor of 27, given its $19 billion valuation last week on Wall Street (when this story was originally written). But this valuation for XenSource is comparatively a lot less sane.

But, it may nonetheless be a very good investment--particularly if the XenSource intellectual property, people, and relationships cause a much larger and richer player to acquire Citrix itself. Citrix was founded 18 years ago by some former IBM employees, and has a very strong relationship (albeit sometimes a competitive one) with Microsoft. Both companies are an obvious possible suitor for Citrix, as is Hewlett-Packard, which has software aspirations, and maybe even EMC if it wants to corner the virtualization market in a way that is disguised by Citrix's large remote access software and services business. Symantec took a lot of heat for shelling out $13.5 billion in stock to buy Veritas back in December 2004, but it might be interested in buying Citrix now as it builds out its own software business. With a market capitalization of nearly $6 billion, driven by a $1.1 billion software business with $196 million in net earnings in 2006, Citrix would fetch a pretty penny. It is hard to say how much given the jittery financial and credit markets this week. Probably a lot more than most companies could pay. Microsoft could afford it, and so can HP. IBM might be able to do it, but it has a lot less cash on hand than the other two.

So why would Citrix pay $500 million for a company that will add only $50 million in sales in fiscal 2008 and will make it book expenses on the order of $60 million to $70 million? Because just like application virtualization was the future that Citrix banked on more than a decade ago, server and application virtualization are the future today that Citrix is ready to make a big bet on.

"As we listened to customers and partners and heard their plans to prepare them to support a more dynamic world, it became clear that we needed to own core technology and competency in the server virtualization space," explained Mark Templeton, president and chief executive officer at Citrix. The company made a lot of hay from its ICA standard, which allows PCs to link into remote servers and share applications and which is the core technology behind Microsoft's Remote Desktop Protocol, which does the same thing. But according to Templeton, Citrix is not trying to own the new virtualization standard.

"We are not looking to create another standard or fragment the market," Templeton said. "On the contrary. We are looking into the market's white space, as we always do here at Citrix, with a strong focus on growing demand by accelerating the broad pervasiveness of virtualization, moving beyond technical and TCO value to deliver strategic value and driving it into the mainstream."

Anyone who pays $500 million for a company with $1 million in sales that has every major IT vendor trying to figure out how to play with it really wants to be the de facto standard. And that is perfectly sane, and maybe, in the case of the Xen hypervisor, it is inevitable. Perhaps it is just not cool to say so. No matter. With over 70 million people sitting at desks using its software, with over 600,000 servers equipped with its wares globally, with over 5,000 resellers, and with over 200,000 customers, Citrix is a very good fit for XenSource to massively accelerate its sales.

XenSource has 80 employees, and Peter Levine, a long-time top executive at Veritas who was brought in last year to take XenSource to the next level, is going to report directly to Templeton as the manager of the Virtualization and Management Division at Citrix. As part of the deal, Citrix is assuming $107 million of XenSource debt, which is part of that $500 million price tag. Citrix is paying for XenSource using a mix of cash and stock, but the exact split has not yet been divulged.