Red Hat wears the trousers in the Linux household

Rethink IT, Nov, 2004

* If we told you that a company was amassing a cash stockpile that was three and a half times its current annual revenues, that it has employed a new director who used to work for Cisco, that it has acquired a business recently and also had a brand new CFO who was used to working in far, far larger companies, you'd think that this was a company hellbent on acquisition. And you'd be right.

So if we tell you that it's a US software company that's been about for more than a decade, you might guess it is Oracle perhaps, or one of the big business intelligence firms like Cognos, or a software development business like BEA.

It is, in fact, tiny Red Hat, primed and ready to take its long awaited place in the big time, by going on a spending spree, buying technology to fit around its almost ubiquitous enterprise Linux implementation.

RISE IN LICENSES

But behind that strategy, viable and necessary as it might be, lies a business that is already profitable, growing in momentum, and which is poised to benefit from a major rise in Linux desktop licenses, something in the past that it was loathe to get involved with.

CEO Mathew Szulik, seems to have deliberately orchestrated this situation over a matter of a few short months. It's almost as if he had said, "Ok I've had enough of this, let's go for it."

At an investors' conference last month, Szulik threw down the gauntlet to Sun, claiming two huge wins, and pre-announced its first ever 10,000 seat desktop Linux license.

So far, after 10 years (the company was launched in 1993), Red Hat's run rate stands at substantially under $200m for the last 12 months. The last quarter it had revenues of $46m, and $88m for the half year, and yet due to the promise of Linux, Red Hat retains a market capitalization of $2.44bn.

So, is Red Hat set to become the Cisco of Linux and build via acquisition? Are there enough Linux software properties out there for the company to buy? Regardless, it certainly looks like it is gearing up to try.

In October Edward Kozel joined the board of Red Hat. Kozel comes fresh from Integrated Finance, a consulting group that specializes in advising big companies on their financial strategy, including M&A activity. In 2001 Kozel was at Cisco, and before that worked at a venture capital group. All of that says that this guy is a regular takeover specialist.

Red Hat also just completed the raising of $600m in convertible debentures in a move designed to give it the financial muscle to acquire companies and to extend its application suite and build its business in Europe and the Far East. Europe so far has been a weak spot when compared with the German originated SuSe Linux, now owned by Novell.

Red Hat had intended to get its hands on just $500m, but the subscription interest was so high that it chose to issue more debentures at the last minute. Again a move aimed purely at giving it the latitude to buy, buy, buy, as and when it finds the right targets.

The move leaves it with $997m of cash in the bank, and it was cash positive to the tune of $30m for the quarter, so its coffers are currently getting fuller every day. And as the market undulates we wouldn't be at all surprised to see it go back to the market again and again.

INCOMING CFO

The other change is the sudden arrival of Charles Peters as CFO of the company, just four weeks before the end of the quarter address. Peters hails from Burlington Industries, an international fabrics company that was sold last year just as it came out of Chapter XI. He is described as a seasoned professional with experience in international finance and had stints at Price Waterhouse, GenRad and Boston Edison.

With the cash and the advisors in place, CEO Szulik has been fast to move, and has followed up Red Hat's December acquisition of Sistina Software by buying some of the key assets from the corpse of Netscape this week, which were held by the AOL segment of Time Warner.

Red Hat has agreed to pay $20.5m in cash to buy effectively two pieces of software that came out of Netscape's Enterprise Solutions business, its Directory Server and its Certificate Management System.

The deal is expected to close by the third quarter.

DIRECTORY SERVER

The Directory Server is an LDAP server, which is a way of building an enterprise global directory that keeps track of employee system access rights, and is a central point for updating things like passwords, email addresses and even phone numbers and PC user settings.

LDAP stands for Lightweight Directory Access Protocol, and came out of reducing the size and increasing the speed of the ISO X500, an ancient directory standard.

The best known global service directory is probably Novell's NDS, which grew out of the side of Netware, and when Novell took the decision to transport NDS to its own Linux platform (the one it acquired when it bought SuSe Linux), along with putting Netware on Linux, Novell must have scared Red Hat into reacting.

Red Hat already has OpenLDAP, an open source implementation of the protocol, in its enterprise Linux distribution, but it probably feels the need to control the technology now that it has Novell breathing down its neck. Also a lot of money went into developing Netscape Directory Server back in the 1996/7 time frame, because it was one of the key ways that Netscape hoped to generate a revenue stream. So it is probably pretty functional compared to the OpenSource equivalents.