Oracle's New Enemy: Red Hat

Red Hat (Nasdaq: RHAT  ) was a fairly harmless company, insofar as Oracle was concerned. Its Linux operating system was mostly a threat to Microsoft (Nasdaq: MSFT  ) .

But that changed instantly when Red Hat purchased JBoss last week. With the JBoss middleware, Red Hat is now a competitor to an array of major companies such as IBM (NYSE: IBM  ) , Oracle (Nasdaq: ORCL  ) , and BEA (Nasdaq: BEAS  ) . Thus, it would not be surprising to see these players move to other Linux providers, such as Novell (Nasdaq: NOVL  ) .

And it should not be a surprise that Oracle's Larry Ellison made some war-mongering comments in Monday's Financial Times. He even alluded to the idea that Red Hat could be "wiped off the map."

Of course, Linux is a popular operating system. However, because it's based on an open source model, anyone can download it for free. But companies like Red Hat and Novell have found creative ways to sell subscriptions and service contracts around Linux.

The next layer is middleware. Think of middleware as the glue that connects various applications -- such as a website to an Oracle database.

Ellison believes that corporate customers want a complete solution. So far, Oracle has every part of the software stack -- databases, business applications, and middleware -- except the operating system.

About the prospective rationale to building a Linux presence, Ellison states that "Most of our big customers would rather have one phone number to call -- the classic 'one throat to choke.' " But I do think there is another strategic rationale, as there are really only two players in the Linux market: Red Hat and Novell. Currently, IBM relies a lot on Novell for Linux. So, in a way, Oracle can "choke" the competition -- IBM being a prime example -- because the competition will have no choice but to deal with a company that is a direct competitor (Red Hat and Oracle).

Also, Linux is a way to prevent Microsoft from encroaching more aggressively into the corporate market. In other words, Oracle could crimp another enemy by buying Novell.

The strategic question then becomes: Does Oracle buy a major player in the Linux market, such as Novell, or develop its own approach? Simply put, big companies like Oracle do not have nimble research and development. Rather, they are good at developing future architectures of existing products and moving old customers to new products.

That's why Oracle has been an aggressive buyer over the last few years. As for Novell, it would give Oracle a new product infrastructure. And the valuation is moderate. Novell is selling at 2.5 times sales, which is consistent with other deals in the software sector. Novell also has about $1.7 billion in cash and cash equivalents.

No doubt, buying a company on buyout speculation is not a good idea. However, in the case of Novell, there is now a group of big prospective buyers.

Microsoft is a Motley Fool Inside Value selection. For more about the newsletter that uncovers underappreciated stocks, click here.

Fool contributor Tom Taulli does not own shares mentioned in this article.


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