Gee, SI has really gotten bad...LOL . HOTS Dumps on Red Hat
HEARD ON THE STREET
More Investors Put Red Hat Back on the Rack
Linux System's Legal Problems, Competition and Insider Sales
Weigh on the Highflier's Stock
By GREGORY ZUCKERMAN
Staff Reporter of THE WALL STREET JOURNAL
Few stocks have been as red hot as Red Hat Inc., the dominant player in the market for the increasingly popular Linux computer-operating system.
But the stock is being doused with a bit of cold water amid concern that the enthusiasm for companies making money from the "open source" Linux system has gone a bit too far. Potential competition for Red Hat, which sells its own version of Linux and provides service and support for the operating system, also is making some wary, as is a torrent of insider sales by top Red Hat executives.
Shares of Red Hat, left for dead after the pricking of the technology bubble in 2000, have tripled in the past year alone. But the stock has slipped to the low $17 range, closing Thursday at $18.09, up 61 cents, after hitting a recent high of almost $22 in late January. And some say there could be more weakness ahead.
Behind the worries is a growing realization among some investors that despite its heady growth, the Linux system has its share of issues to overcome. Last week, SCO Group Inc. sued DaimlerChrysler AG and AutoZone Inc., the latest in a series of lawsuits SCO has brought against Linux providers and users. SCO, a software company, contends that part of Linux violates copyrights that the company holds. SCO already has sued Linux vendors, including International Business Machines Corp. and Novell Inc.
While it isn't clear whether any of the litigation will ever succeed, it could begin to make some users more wary of embracing the Linux system, according to some analysts. While Linux backers have attempted to assuage customers by establishing a legal fund and pledging to indemnify them, concern could grow if SCO is successful in court. A recent poll conducted by the Gartner Group suggested that about 27% of its more than 100 respondents were slowing their deployment of Linux, or avoiding the operating system, as a result of fears of litigation. If the caution grows, it could hurt Red Hat. "Every single quarter for the last four quarters, new customers have just exploded. SCO does not have an impact today on the adoption of Linux," says Red Hat's chief financial officer, Kevin Thompson. "Those that have expressed concern are not the ones who we expect to adopt Linux in the next 12 months, they're not leaders in technology."
Meanwhile, some say Linux could begin to face more security problems, just as the Windows system has been encountering such problems. "As it enters the mainstream, Linux will be more of a target for viruses and hackers," predicts Charles Di Bona, an analyst at Sanford C. Bernstein & Co. who covers Microsoft Corp.
Meanwhile, last year, Novell purchased a rival company that serves the Linux market, and could emerge as a key competitor to Red Hat, thanks to Novell's larger sales and support staff. Gartner estimates that Red Hat controls as much as 80% of the U.S. server market for Linux. If Novell can make headway, it could crimp that dominance. While Red Hat's growth likely will continue, the easy pickings may be over. Almost 15% of all new servers currently are being shipped with the Linux system, and the figure could hit 20% in the next few years, according to analysts.
But many of the gains are coming as customers flee from the Unix computer operating system, which could garner well under 10% of the market for new shipments by next year, according to analysts. At that point, Linux and Microsoft's Windows system increasingly will go head-to-head for market share, making it harder for both to gain. While the overall market continues to grow at an impressive pace, in part as a result of the fact that Linux is cheaper than other systems, some analysts say there still is reason for caution. "It's not that Linux won't get traction, but there is a lot of hype around Linux," says Mr. Di Bona. "I would caution that there is a bit too much euphoria about Linux-related companies. It's not a perfect system."
Mr. Thompson of Red Hat says: "We've just started to scratch the surface" in many areas of the market. Stock sales by Red Hat executives also put a damper on the picture. Chief Executive Matthew Szulik exercised options on 1.4 million shares this year, and sold them all -- as well as an additional 500,000 or so shares from his existing holdings, according to Thomson Financial, which tracks insider sales. While insider selling has been picking up throughout the tech world, and Mr. Szulik's selling is being conducted by an outside party as part of a plan he established earlier this year, there is still reason for caution, according to some analysts. "He's definitely selling in larger quantities than ever before," says Kevin Schwenger, an analyst at Thomson Financial. "It does stand out."
Mr. Thompson of Red Hat said: Mr. Szulik's "selling has been a fraction of the selling of other CEOs from 1999 to 2004, and it's been a small percentage of his total holdings." Mr. Szulik holds about 7.6 million shares of Red Hat, according to the company. Other Red Hat executives also have been selling stock and have filed to sell more in the months ahead, adding to supply in the market.
To be sure, Red Hat shares aren't likely to plunge anytime soon. Earnings growth should continue to be strong: The company is expected to post earnings of 19 cents a share in the recently ended fiscal 2004 and 36 cents in fiscal 2005, up from nine cents in 2003. Linux is one of the only hot themes in a software industry still struggling for new growth ideas. And since Red Hat is one of the only plays on this growing Linux market, some investors say that if the stock gets cheaper, they will consider stepping in with buy orders.
Still, Red Hat shares don't have much room for disappointment. The stock is trading at a huge 93 times expected earnings for fiscal 2004. And about 6% of Red Hat's shares were borrowed and sold last month, a figure that is about three times that of the average stock, suggesting that many investors remain convinced the stock's heady run may be over.
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