SCO Group Soars on Upgrade

Shares of SCO Group(SCOX Quote) skyrocketed to their highest level in nearly three years after a Wall Street brokerage firm initiated coverage of the stock with a buy rating.

Deutsche Bank analyst Brian Skiba accompanied his buy rating with a $45 price target, but cautioned that investors should consider an investment in SCO "extremely high risk and volatile." Shares of SCO propelled $5.13, or 33%, to $20.66 in recent trading.

Buying SCO is akin to buying a call option on the company's controversial lawsuit against IBM(IBM Quote), Skiba wrote in his research note. In its suit filed in March, SCO charged IBM with misappropriating SCO's UNIX source code in its Linux business. But the case is complicated because of how SCO ended up with rights to Unix and the code's relationship to Linux.

As a "call option," an SCO investment would not be likely to expire before spring 2005, when the IBM case is scheduled to go to trial, Skiba wrote. In an interview, Skiba said he could not handicap the lawsuit but noted that most lawsuits settle before going to trial.

Accordingly, Skiba advised investors not to discount a potential takeout of SCO, particularly if the firm is able to slow down the adoption of Linux. SCO management has indicated $1 billion would be an acceptable takeout price -- about one-third of the $3 billion plus potential punitive damages SCO is seeking from IBM.

Although his buy rating was triggered by the legal case, Skiba calculated his $45 price target by forecasting earnings and revenue based on licensing agreements for Unix and other licensing opportunities. He estimated SCO could post earnings per share of $1 in calendar-year 2003 and $2.29 per share in 2004, leading to a forward price-earnings ratio of 20.

Skiba acknowledges that his call on SCO may be taken as heresy in the Linux community, but said it's important to separate the stock from the company. In addition, he argues that the idea of Linux being created by thousands of volunteer programmers is largely myth, given that companies like IBM, Hewlett-Packard(HPQ Quote) and others have paid thousands of employees to improve the operating system and build a business around it.

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