Linux Reality Doesn't Match Hype

Almost every week, it seems, another government is jumping on the Linux bandwagon, badmouthing Microsoft(MSFT) all the way. But for all the headlines, the open-source software movement remains very much a fringe business, raising troubling questions for investors who've plowed into publicly traded Linux providers in the past year.

And plowed they have: As of Tuesday's close, Red Hat(RHAT) shares were up 110% in the past 12 months, while shares of Novell (NOVL), which recently acquired Germany-based SUSE Linux, had soared nearly 150%. Those returns compare quite favorably with the 33.4% gain by the Nasdaq Composite and 26% rise by the Goldman Sachs Software Index in the past year.

Yet, "in spite of all the talk [about Linux], there's still not a lot happening," said Robin Simpson, a Gartner research director in the Asia Pacific region.

Investors today risk making the same mistakes as those who wholeheartedly embraced the IPOs of Red Hat and VA Linux (now named VA Software (LNUX)) in 1999. Shares of both soared initially, setting all-time intraday highs of more than $150 and $300, respectively, before suffering precipitous declines in the 2000-2003 bear market.

Brazil's recent support for open-source software and Sun Microsystems' (SUNW) recent agreement with a government-sponsored consortium in China suggest Linux has evolved from its early concept phase. But the reality is that Linux is still being used only under very limited circumstances, while the revenue growth of publicly traded Linux providers has not nearly matched their stock price appreciation.

Of course, low Linux sales should not be a huge surprise given the unique open-source model, which distributes software free over the Internet and draws on volunteers around the world who offer free technical advice online.

A "weirdo competitor" is how Microsoft CEO Steve Ballmer described Linux in a recent Business Week interview. "There's no company behind it. You don't know exactly who builds it. It's free," Ballmer said. "I prefer to say: 'Look, what we have here is a small price disadvantage.' "

That statement might represent a rare case of understatement from the normally bombastic Ballmer. The reality is Microsoft is hardly disadvantaged in its competition vs. Linux.