Understanding the Red Hat Phenomenon

The success of the Red Hat IPO has spawned the inevitable bevy of me-too Linux outfits, not one of which is likely to be as successful as the original.
Author:
Publish date:

Can we go back for a minute? To the Red Hat (RHAT) IPO last week?

There's lots of gasping and wheezing still about Red Hat's performance. Not only did it more than triple from an offering price of 14 to 54 on its

opening day last Wednesday, but it somehow escaped the Second-Day Swoon that has characterized tech stocks and dot-coms this summer, closing the next day at 72 5/8 -- up another 40%. Even more -- hear the gasps? -- it had the nerve to close Friday at 85 1/4, up 17% more. (OK, so it did drop 13% Monday to close at 74 1/2.)

Even more interesting, look at the volume charts for Red Hat: Every day last week Red Hat opened with a big surge, driving it to new highs that it managed to hold. That indicates orders stacking up overnight, for execution at opening. In other words, there was a lot of support for the stock from real buyers, such as institutions, not just a random series of intraday pops from daytraders.

While Red Hat fell in today's choppy market, and looks likely to sag some this week from its roaring performance last week, that doesn't diminish the story here: Red Hat had a hell of an opening week.

What gives? Don't these guys

understand

? Aren't tech IPOs supposed to soar the first day, but sag before close, then ratchet down for the next few days?

Red Hat and its lead underwriter,

Goldman Sachs

, did a lot of things right here, three of which led directly to this remarkable performance:

  • Red Hat has done a great job over the past year of massaging the press, getting itself identified repeatedly as THE source of wisdom on Linux, THE commercial source of Linux, THE vendor of more-or-less-standardized Linux. All of which it is, sort of, but not by nearly so large a margin as the press has reported. Red Hat has become the only important brand name in the Linux business, Caldera and the other also-rans notwithstanding. That translates directly into shareholder value.
  • Red Hat was the first mover to market in an incredibly hot corner of technology. Those who pooh-pooh the importance of first-mover status in many ways in tech stocks should take note of this one. Sure, if Red Hat hadn't done a lot of other things right, this one wouldn't have headed for the moon. But being the first recognizable Linux developer to come to market was the big accelerator. Give me a fully realized, world's greatest-product box, or a fast path to market, and I'll take the latter every time.
  • Red Hat followed this year's practice of controlling demand by offering a modest number of shares: Just 6 million, which at the offering price produced about $84 million in cash for Red Hat's treasury. Smart people never sneer at $84 mil, but that sum wasn't nearly so important for Red Hat, of course, as was the credibility it created for the company -- and the amazing instant wealth it created for its founders and other insiders.

Red Hat, of course, also delivered a superior product, and backed it up with a business plan which makes sense. Part of the key to survival and profitability in the perilous Linux market -- remember, you can get Linux for free via download from several sites, rather than paying $50-$80 for Red Hat's tweaked version -- is selling support, and that's where Red Hat will, I'm convinced, earn its future. Support starts at $225 per incident, and goes up to a one-year $55,000 24/7 unlimited-calls contract. Indeed, I think Red Hat will see the day, and maybe before very long, when building and shipping its versions of Linux becomes almost a nuisance ... but a necessary one, to sign up support customers.

I can't list the positives for Red Hat in this IPO without adding my voice to the angry chorus which has condemned

E*Trade

(EGRP)

for its botch of Red Hat's smart decision to try to reward its friends in the Linux community by making sure they could get some small allotments of shares at the offering price. E*Trade's screw-ups left an influential group very upset. You can read the details of this, and the angry responses, at many places on the Net, including

Salon's

(SALN)

article, and on that Valhalla of programmer angst,

slashdot.org. Most of the unhappy Linux programmers' anger has been quite properly focused on E*Trade, but some has also spilled over onto Red Hat. Since Red Hat must walk a narrow line in the Linux community going forward -- continuing to march toward profitability while not alienating a group that often sees profits as evil -- it needs to clean up after E*Trade's mess. And fast.

When I wrote here

last month about Red Hat's impending IPO, I said I expected big things, and Red Hat delivered. But I confess that I didn't anticipate the powerful after-offering support.

One absolutely inevitable result of the big success in the market: a speedup in the planned IPOs of other major Linux vendors, including

VA Linux

, Caldera,

Linuxcare

and

Cygnus Solutions

. Another nearly inevitable result: They won't do nearly so well as has Red Hat.

Caldera CEO Ransome Love last week characterized the Red Hat IPO as "a rising tide that lifts all boats," which he said would make it a lot easier for Caldera to come in with its own strategy. Well, Ransome, true enough, I suppose -- without this IPO, the other Linux companies wouldn't have had a prayer of coming public this summer -- but we should acknowledge that this rising tide won't float the other boats nearly so high as it has Red Hat's.

One final bit of Red Hat miscellany: Tim O'Reilly, owner of

O'Reilly & Associates

, one of the most important computer-book publishers and a long-time supporter of the "open-source" movement that has grown up around Linux and other non-commercial software packages, asks an interesting question about Red Hat's future:

Has Red Hat, Tim wonders, put itself in an untenable position with this IPO? On the one hand, to continue as a Linux producer it must remain committed to the principles of open-source Linux, contributing its improvements for free to the Linux community. On the other, it now has a fiduciary responsibility to act in the best interests of its shareholders -- which, we can reasonably expect, will often

not

be the same as the interests of the Linux community.

A private company can handle that paradox easily -- as Red Hat, Caldera and others have, so far. But a public company?

Has a law firm somewhere already started a file titled Red Hat Shareholder Class Action Notes?

Tech Link

: If you're invested hip-deep in Silicon Valley companies,

City University of New York

theoretical physics prof and futurist

Michio Kaku

may shake you up. In a

Philadelphia Inquirer

story last week, Kaku talked about moving ahead in computer technology. By 2020, Kaku believes, Silicon Valley may become America's newest Rust Belt, as we move on to etching "chips" onto molecules. Worth a read -- with all the usual caveats about being fooled by futurists...

Jim Seymour is president of Seymour Group, an information-strategies consulting firm working with corporate clients in the U.S., Europe and Asia, and a longtime columnist for PC Magazine. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. At time of publication, neither Seymour nor Seymour Group held positions in any securities mentioned in this column, although holdings can change at any time. Seymour does not write about companies that are consulting clients of Seymour Group, or have been in recent years. While Seymour cannot provide investment advice or recommendations, he invites your feedback at

jseymour@thestreet.com.