ALEXANDRIA, VA (January 6, 2000) -- There's nothing quite as instructive as a really BAD example. So let's take a break from talking about great companies -- potential new Rule Makers -- to remind ourselves of how bad it can get if we don't do our homework. Let's refresh our sense of skepticism with a close look at a soon-to-be-public company I mentioned last week: LinuxOne.

On September 22 of last year, shortly after Red Hat's (Nasdaq: RHAT) spectacular first day in the market, LinuxOne filed for an initial public offering (IPO) with an S-1 statement almost word for word identical to Red Hat's. The only difference was that LinuxOne had no earnings -- literally $0.00. It had no INCOME. It had never sold a product. It had only incorporated (in Nevada, a state with no disclosure requirements) a few months earlier. The company's entire assets on the S-1 consisted of about $150,000 cash (from their president buying stock in his own company) and a little under $5,000 of equipment (mostly their Web server). This was listed in dollars, not in thousands as is customary, apparently to make it look bigger.

The president of the company, Wun C. Chiou, left his previous position as president of NetUSA (OTC: NTSA) in March to found LinuxOne. NetUSA is a penny stock traded over the counter that issues unsolicited commercial email (i.e., spam) to advertise its products.

LinuxOne's first product (which was still in beta test and had been announced less than a month before they filed for an IPO) was reviewed as "an aging Red Hat release with the serial numbers filed off."

On the basis of this, LinuxOne filed to sell 3 million shares to the public at $6-$8 per share, thus cashing in on the Linux hype for at least $18 million, and hopefully way more. I don't even think the Fools need to DO an April Fool's joke this year, this tops e-meringue in my book.

How can LinuxOne even HOPE to get away with this? Well, did you notice that Salon.com's (Nasdaq: SALN) stock just about doubled in one day when they simply issued a press release stating that they would be providing some content for one of Red Hat's websites? LinuxOne wants the Nasdaq stock symbol LINX, and VA Linux has the stock symbol LNUX. Maybe some of those billions will rub off, eh?

I've been writing about Linux in this column since way back, and I'm one of its greatest fans here at the Fool. Last I checked, the combined market capitalization of VA Linux and Red Hat was over $20 billion, with many more eagerly awaited IPOs like LinuxCare and TurboLinux waiting in the wings. But right now, the single most prominent force driving the valuations of Linux companies is hype. Linux is a "hot area," the technology du jour, as were "push technology," Java, the Internet, and anything-dot-com, before it. A few decades ago, it was electronics and plastics. There are a lot more dollars pursuing investment opportunities in this area than there are honest investment opportunities.

Presently, the mention of Linux in a press release can move stocks, even if all they did was simply convert their Web server to running under the Linux operating system. This is because a certain type of investor tries to jump on this kind of trend without a clue about where it came from or where it's going. And like all mindless sheep following the herd, these guys regularly get fleeced.

The truth is, the Linux market is just like the PC market: thoroughly commoditized. Two guys in a garage can easily assemble a working system out of parts, and just as you can stick a Compaq hard drive into a Dell computer, you can upgrade a Red Hat Linux system's Web server from a SuSE CD (or just download the new one off the Web directly from www.apache.org). This doesn't mean that profitable companies can't play in this space, just that participation isn't automatic domination. The difference between Tropicana and some guy with an orange tree in his back yard isn't the juice, it's the company. Saying, "Hey, I can do that, too," doesn't make you worth billions. Add what value you can, establish relationships with customers (that's all brand name is anyway), hire good people, grow your infrastructure. THEN have an IPO.

LinuxOne is not just a case of the emperor not having any clothes, or even the emperor not actually being royalty. As far as anybody can tell with LinuxOne, what is sitting on the throne is a dime store mannequin. But you can't tell this from LinuxOne's press releases. It opened offices in Taiwan, which isn't that big a deal when you realize its CEO is from Taiwan and probably still has friends and family there. Then, it announced a $500,000 deal with a company called "Power Source." Income? Not really. Power Source runs flea-market tables in California. If Power Source actually had $500,000 of cash to spend on anything, why would their e-mail address be a Hotmail account? If you call Power Source's phone number (on their Web page) before 9 a.m., you wake the poor guy up. But what Power Source CAN do is agree to accept $500K of products for LinuxOne and sell them on commission, remunerating to LinuxOne whatever they could make from the profits of selling it. Of course, that's not how the press release is worded.

What products Power Source will try to sell for LinuxOne is still up in the air, of course. LinuxOne has proposed selling renamed Red Hat CD's, but since you can get those for under $2 each by mail (from www.cheapbytes.com, among other places), that didn't pan out. They've also tried installing Linux on a hard drive and then selling the hard drive, but nobody seemed interested. The "quest for a product" continues, but that won't slow down the IPO.

This sort of thing puts our whole philosophy of paying extra for quality (QuaVa) in perspective a bit, doesn't it?

I can't repeat this enough: DO YOUR OWN HOMEWORK. It's a vicious market out there, buyer beware. Don't blindly trust a company's press releases, they're advertising. Don't trust what analysts say about it. Even the Fool has been small-f fooled before, right here in this portfolio. Our original paper money "Simpleton" portfolio included Oxford Health Plans (Nasdaq: OXHP), which one day lost 75% of its value due to "accounting irregularities." I know the stock market's booming like mad but DON'T go on margin, DON'T gamble away money you can't afford to lose, and DON'T put all your eggs in one basket. We don't always repeat that often enough here, so you'd better get in the habit of repeating it to yourself.

- Oak