Monday, October 30, 2006

Can Red Hat Survive?

Oracle's bid to steal business away from Red Hat has thrust the world's largest Linux software distributor into an extremely challenging position. It might even signal the beginning of the end for Red Hat, industry analysts and insiders said.

Red Hat's shared tumbled 25 percent Thursday after Oracle, the giant database software company, said it would offer support services for Red Hat's open source Linux software—at half the price Red Hat currently charges. The move was almost certain to cut into the lucrative support contracts that Red Hat relies upon for the bulk of its revenues, prompting some industry watchers to suggest the Linux upstart could become a takeover target for Oracle.

Enterprise Applications Consulting analyst Joshua Greenbaum said Oracle's gambit puts Red Hat in a “very dangerous position” because it doesn’t own intellectual property and is just offering services. “I don’t think this is the end of Red Hat,” he said. “This is the beginning of the end, and it’s going to be up to them to show how to pull [their] feet out of the fire.”

Oracle CEO Larry Ellison caused a stir at the OracleWorld conference in San Francisco this week by announcing that his company would begin offering support services for Red Hat's Linux software. Oracle said it would also indemnify customers against any intellectual property issues arising from using the software. Not everyone believes Oracle's announcement will prove disastrous for Red Hat.

Sanford & Bernstein analyst Charles Di Bona said Red Hat will have to cut prices to survive, even though that will hurt its margins. Others, such as Billy Marshall, chief executive of software appliance company rPath, suggest Red Hat will ultimately survive. “I see this as being a distraction for the Red Hat team in the near term,” said Mr. Marshall, who was previously vice president of North American sales at Red Hat.

Matthew Szulik, Red Hat's chief executive, said Friday that his company would not cut prices, despite Oracle's move. Mr Szulik said Red Hat welcomed the competition and would continue to sell its products along with Oracle's database software. Red Hat shares rebounded Friday, gaining more than 8 percent in midday trading, as the company said it plans to buy back as much as $325 million of its stock and bonds.

Some analysts suggested Mr. Ellison was trying to drive down Red Hat's market capitalization, making it cheaper for Oracle to buy Red Hat. “Given the amount of drama involving the PeopleSoft acquisition, you can’t rule out the possibility that this is a move by Oracle to make Red Hat a more affordable acquisition target,” said Raven Zachary, an analyst with the 451 Group.

Oracle acquired applications vendor PeopleSoft in January 2005 for $10.3 billion following an 18-month war of words that set new standards of nastiness in Silicon Valley. While some people think that Oracle wouldn’t benefit much by acquiring Red Hat, Mr. Zachary said the Redwood Shores, California-based company would get Red Hat’s talent and customer relationships after the acquisition. Red Hat’s current market capitalization is $3 billion.

Getting Emotional?

Dave Dargo, CTO of open source database company Ingres, thought Mr. Ellison's decision to offer Red Hat Linux support was an emotional response to Red Hat’s acquisition last April of JBoss, an open source middleware provider and Oracle competitor. “I don’t think this is a business decision, this is an emotional decision,” Mr. Dargo said. “It’s just a matter of being greedy and emotional and they don’t think Red Hat should be getting the business.”

During his keynote speech at Oracle’s conference in San Francisco on Wednesday, Mr. Ellison justified this move, saying that it was capitalist in nature. “This is capitalism and we are competing,” he said during a Q&A session. “This is not about Red Hat. This is about increasing the adoption of Linux and moving it up to the mission critical spot in the data center."

Mr. Dargo countered that Oracle's move indicated a lack of understanding of the value that Red Hat’s support and service provide. But he noted that Red Hat could be vulnerable if Oracle manages to privde better service. “If the strategy at Oracle works out, Red Hat is going to face some serious issues, but I don’t think it is going to work out,” he said. “There are lots of opportunities for Red Hat to do some aggressive and creative things to turn around.”

Red Hat CEO Matthew Szulik was not available for comment, but spokesperson Leigh Day said the opportunity for open source just got bigger. “Oracle’s announcement further validates Red Hat’s technical leadership,” he said. “We will continue to optimize Red Hat Enterprise Linux for Oracle and compete on value and innovation."

That may be so, but Oracle's move means that Red Hat will suddenly face a rival with deep pockets that has demonstrated a will to crush rivals. Mr. Greenbaum notes that Red Hat's position is all the more precarious because it doesn't own the intellectual property behind Linux and is extremely dependant on sales of service contracts. "The fact that you are a service provider with having a lock on a software license is a very vulnerable position to be in," he said.

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