Lindows Hopes to Capitalize on Linux Fervor, IPO Revival

As the hoopla over Google's IPO recalls the go-go days, at least one smaller, lesser-known company is hoping for a piggyback ride.

Lindows, which sells Linux for the desktop, recently filed to raise $57.5 million. In addition to taking advantage of the IPO frenzy over Google, Lindows is also poised to capitalize on enthusiasm surrounding all things Linux. A successful IPO would make the San Diego, Calif.-based firm a member of a small cadre of public companies that sell the much-ballyhooed open-source operating system.

But don't expect another Red Hat ( RHAT), the Linux vendor whose market cap has swelled to more than $4 billion. While Lindows' product gets strong reviews, its prospectus is littered with red flags. The 3-year-old Lindows also faces daunting competition -- and legal challenges -- from Microsoft ( MSFT), among other tech heavyweights.

"This is a throwback to the bubble era," John Fitzgibbon, editor of the newsletter IPO Weekly at www.123jump.com, said of a potential Lindow's offering.

Indeed, Lindows' $4.1 million loss on a minuscule $2 million in revenue in 2003 and $11.9 million accumulated deficit inevitably conjure up memories of dot-com days. (By comparison, Red Hat reported a loss of $91,000 on $10.8 million in revenue in the fiscal year before its 1999 IPO.)

Although its outlook may reflect post- Enron skittishness, Lindows' auditor, PricewaterhouseCoopers, said the company's recurring losses, negative working capital and accumulated deficit "raise substantial doubt about the company's ability to continue as a going concern."

Bubble-era comparisons notwithstanding, potential Lindows investors shouldn't expect the stratospheric one-day pop that was common during that more exuberant time. The fact that Lindows will go public via W.R. Hambrecht's OpenIPO Dutch auction virtually guarantees no such jump. That's because investors submit bids before the stock trades, which are then used to determine the actual public offering price. Consequently, any potential run-up is already reflected in the stock's opening price.

"Don't expect a moonshot," Fitzgibbon said.

Proceed With Caution

W.R. Hambrecht touts its Dutch auction system as a more democratic IPO that gives individual and institutional investors equal access to bid on shares. But only nine companies have ever used the OpenIPO system -- and just three out of 229 IPOs since January 2002, according to IPO Vital Signs. Furthermore, the aftermarket performance of such firms is uneven.

Google's auction might change opinions about such offerings, but OpenIPO might be the only option for Lindows. The company's tiny revenue may be lower than what institutional investors require, said Dion Cornett, an analyst with Decatur Jones, who covers Red Hat and Novell ( NOVL). A handful of hedge fund sources said they'd also stay away.

That leaves retail investors, who are advised to proceed with caution.

"People should not be touching Lindows," said FTN Midwest Research software analyst Trip Chowdhry. "As an investor, do you want to go back to the dark ages of dot-com, where you gave money based on concepts and hoped and prayed, or reward companies that have worked to establish niches ... and continue to execute well?" he asked, putting IPO-bound Google and Salesforce.com in the latter camp.

Lindows' "unproven concept" is selling its Linux desktop operating system and complementary subscription services bundled with low-cost personal computers, targeting primarily smaller PC manufacturers and international markets.

Not everyone is as critical as Chowdhry, however. "Fundamentally, I like their position on the low end," said Cornett, noting it's an area untouched by Red Hat and Novell, which are targeting business customers.

Earlier this year, Prudential Securities analyst Brent Thill enthusiastically described his experience buying and then navigating a $231 Lindows PC from Wal-Mart ( WMT). "It amazed us how simple, or more accurately how familiar, the whole experience was," Thill wrote, reporting no notable problems navigating the open-source version of Microsoft Office, going online, installing drivers and playing MP3s.

Going Dutch: W.R. Hambrecht's Auctions Enjoy Mixed Results
Company Offering Price IPO Date Current Stock Price* % change to date
Genitope $9 10/30/2003 $9.40 4%
RedEnvelope 14 9/25/2003 9.62 (31)
Overstock 13 5/29/2002 39.97 207
Briazz 8 5/2/2001 0.17 (98)
Peet's Coffee & Tea 8 1/25/2001 22.4 180
Nogatech 12 5/17/2000 Bought in 2000 for $170 million, or equivalent of $10.46 a share, in 2000 NA
Andover.net 18 12/8/1999 Bought in 2000 for $800 million to $1 billion NA
Salon.com 10.50 6/22/1999 0.12 (99)
Ravenswood Winery 10.50 4/9/1999 Bought in 2001 for $148 million, or $29.50 a share NA
*Stock price as of April 27, 2004. NA = not applicable.
Sources: W&R Hambrecht, Baseline, news reports.

The biggest obstacle to mass adoption of Linux on the desktop, Thill said, is lack of third-party applications designed to run on Linux. He believes that will change quickly as a result of the "unabated popularity surge of Linux," but he acknowledged that mass-market adoption is still three to five years away.

Of course, Microsoft is the heart of that obstacle to mass adoption.

Good Reviews, Big Obstacles

Microsoft's dominance on the desktop -- with more than 90% market share -- has resulted in countless applications being written on the Windows platform. Saying that it's no easy task to take on Microsoft -- which still will have roughly 1,000 times more cash than Lindows after its IPO -- is an understatement.

Through a rash of trademark suits in eight different countries, Microsoft has already strong-armed Lindows into changing the name of its operating system to Linspire -- despite Microsoft's failure to win injunctions from U.S. and French courts. Lindows is also embroiled in legal battles with its insurance carrier over paying for Microsoft-related court fees, and is entangled with another company called Xandros over a loan from Lindows.

In addition to Microsoft, Lindows could face more intense competition from myriad companies, including Novell, which recently acquired Germany-based SUSE Linux; Red Hat, which is planning to retest the desktop waters; and Sun Microsystems ( SUNW), which announced a big Linux deal in China late last year.

Finally, Japanese's Livedoor, a tech firm that generated 11% of Lindows' revenue in 2003, recently acquired Turbolinux, Asia's largest distributor of Linux.

Cash to Burn

Such intense competition, combined with Lindows' uninspiring financials, raises the question: Why go public now?

Lindows did not return a call for comment, but said in its prospectus that the IPO, combined with its $250,000 in cash on the books, would provide funding for two years.

The funds also will pay off a $10.4 million, 10% interest loan from CEO Michael Robertson, who is no stranger to shaking up big, established markets. He sold his last venture, MP3.com, to Vivendi ( V) for $372 million in 2001 after being sued for copyright infringement by the recording industry. Robertson also is the founder and CEO of Internet telecom company SIPphone, which operates out of the same building as Lindows.

"Basically they're running out of cash," concluded Chowdhry, who also suggested the IPO may be an exit strategy for the company's owners and original investors.

Still, the timing may be right. Interest in Linux is high, but public Linux companies are still few and far between, and many investors have been turned off by Red Hat's sky-high valuation, which is 60 times fiscal 2005 earnings.

"The wind is definitely in the back of the IPO market," added IPO Weekly's Fitzgibbon, noting 50 deals have already priced this year, a number not reached until mid-November in 2003.

Perhaps more than Google's offering, Lindows's presumptive IPO will reveal whether investors have learned from the hype-filled days of yesteryear.

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