Fool.com: Red Hat and Cygnus Form Linux Link Up (News) November 15, 1999

Red Hat and Cygnus Form Linux Link Up

By Brian Graney (TMF Panic)
November 15, 1999

Putting its high-flying stock to use for the first time, Linux operating system and services provider Red Hat (Nasdaq: RHAT) announced today that it will acquire fellow open source software specialist Cygnus Solutions for $674 million in stock, or over 6.6 million shares. The news sent Red Hat's shares up about 7% this morning, adding to the cumulative 650% market value surge the company has experienced since coming public three months ago. With the value accorded to those shares, Red Hat was able to nearly double its size in one easy pull of the stock swap trigger, adding privately held Cygnus' 181 employees to its own worldwide crew of 235.

The key to the merger is Cygnus' experience in providing GNU technologies for desktop application development environments and Internet and embedded systems. "The merger will create a single, worldwide source that lets developers rapidly create Linux applications for servers and small devices -- accelerating the adoption of open source technologies in enterprises worldwide," said Red Hat president and newly installed CEO Matthew Szulik.

Not content with its main task of trying to replace operating systems such as Microsoft's (Nasdaq: MSFT) NT or Sun Microsystems' (Nasdaq: SUNW) Solaris on enterprise servers everywhere, Red Hat is looking ahead to where the next opportunities will lie in a world that is becoming increasingly more connected. Today's deal is a vote of confidence by Red Hat that personal digital assistants (PDAs) and wireless "smart" phones will lead the way in the future -- using open source operating systems and applications, of course.

As the continuing race to build global wireless networks for Internet data and the value explosion in companies like Nokia (NYSE: NOK) have shown, post-PC-centric computing is where it's at. Obviously, the fast-growing Red Hat needed to throw Shadow Man's hat into the ring at some point or risk missing out on the business opportunity. Maybe open source will dominate these emerging environments and maybe it won't. What Red Hat couldn't afford to do, however, was watch the shift occur without staking a claim to some portion of what could amount to a massive value creation area in the future.

Peering around the curve and into the future is the major point investors in companies such as Red Hat need to understand, since the firm's valuation can't be explained any other way. Using historical valuation metrics to determine intrinsic value in this instance just won't cut it. Understanding the issues related to Red Hat's place in the open source software movement and where the movement itself is going in the coming years are the more relevant, and ultimately important, considerations in determining where Red Hat goes from here.

As Legg Mason portfolio manager Bill Miller posited in the most recent issue of Barron's, "Potentially disruptive technologies such as the Internet may change long-established economic relationships, providing an opportunity for those who correctly discern the changing economic patterns before they are reflected in market prices." Only time will tell if Red Hat's move today will pay off big for shareholders down the road. But in the meantime, investors can do themselves a favor by getting acquainted with the issues associated with the "potentially disruptive technology" and "changing economic pattern" of open source computing.

Related links:
Red Hat Web site
Cygnus Web site
Red Hat message board

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