With most of Wall Street betting against it, SCO Group ( SCOX) could face a last chance at redemption in a series of court battles that will play out over the next few weeks. Tiny SCO is best known as a legal play on its various courtroom strategies to claim rights to the technology underlying the Linux operating system. But with a string of setbacks in its rearview, SCO currently trades 75% below its 52-week high and is still the target of aggressive short-sellers. It's been nearly 22 months since the company initiated its battle over Linux with a multibillion-dollar suit against IBM ( IBM). In that suit, SCO claimed IBM breached a contract with SCO by misappropriating Unix code, which SCO claims it owns, in IBM's Linux business. Since then, IBM has countersued, rival software outfit Novell ( NOVL) has claimed ownership of the Unix copyrights, SCO has sued Novell for slander, and SCO has sued Linux users DaimlerChrysler ( DCX) and AutoZone ( AZO). Investors initially liked the prospect of SCO potentially harvesting licensing fees from a large number of Linux users, and the stock has been above $10 as recently as April. But the optimism steadily dissipated as SCO has enjoyed little success pressing its case in court over the past year, even with high-profile attorney David Boies handling the case. Among other setbacks, a judge dismissed most of the Daimler suit. Dion Cornett of Decatur Jones, the only analyst who still covers SCO, noted that his pick of the year for 2004 was a short on SCO, whose volatile shares started 2004 at $17 and swung to as low as $2.76 in November. (Cornett upgraded his rating to market perform from sell in August when the stock was at $4.05, largely because he thought the easy short money had been made and a settlement looked more likely.)
The problem is that SCO has yet to offer compelling evidence that Linux contains Unix code and that SCO even owns the rights to that code, according to Cornett and lawyers tracking the case. "They have not presented an argument compelling to IT managers, who understand software," Cornett noted. That makes him think SCO would have an even more difficult time making its case before a less tech-savvy jury. A jury trial in the IBM case has been scheduled for November 2005. Heather Meeker, a lawyer in the Silicon Valley office of Greenberg Traurig who has been watching the litigation, echoed that sentiment. "The general perception is that SCO's case is very weak, and when they are called upon to provide the information that IBM has asked them to provide -- which is to identify the exact infringing material that has been put into IBM products such as Linux -- they will not be able to provide anything convincing," said Meeker, who specializes in business transactions for technology clients and open-source software licensing issues. "The more you know about the facts, the weaker the case seems." Still, one buy-side source who is long the stock said it's premature to dismiss SCO before IBM turns over discovery materials in the nearly two-year battle. Among other things, SCO wants access to what is known as IBM's "revision control system," which tracks and documents aspects of Linux's development and could shed light on any role Unix had in its genesis. SCO also charges that IBM has failed to provide it with all relevant correspondence about Linux from its top executives. The buy-side source believes that the judge's ruling on that motion-to-compel could be a major catalyst for SCO's stock if it's in SCO's favor. The ruling is expected in the next couple of weeks.
"The bottom line is people are not looking at the case properly," said the source, who asked to remain anonymous. "People are saying what should be vs. what's legally right." But Cornett said SCO's request for more discovery "almost looks like a stalling tactic" to avoid facing a hearing on IBM's request for partial summary judgment in the case. Cornett believes a partial summary judgment hearing, potentially in late January, could be the next catalyst for the stock. IBM declined to comment for this story. But in its opposition to SCO's motion to compel discovery, IBM claims it has complied with a court order on discovery, producing nearly 1 million pages of documents, including those from executives, and more than 40 million lines of source code to SCO. The IBM case is complicated by a federal judge's sealing of some documents and a transcript of a court proceeding. "I don't know what the judge knows and IBM knows," noted David Kramer, a partner at Wilson Sonsini Goodrich & Rosati who specializes in intellectual property law. "We are still operating at an informational disadvantage, and so is the market." Indeed, sources say that IBM has produced emails revealing the use of a derivative of Unix code, but they have been sealed by the court. Of course, all of SCO's litigation against IBM is moot if Novell successfully shows that it still owns the copyright to Unix software, which SCO claims it purchased from Novell in 1995 for more than $100 million in stock. Novell, which sells Linux services and has received $50 million in funding from IBM, claims that SCO's purchase of Unix from Novell excluded the transfer of associated Unix copyrights to SCO, and it cites several documents to support that argument.
But the buy-side source wondered why SCO would spend more than $100 million and not end up with a legal right to defend its technology. The buy-side source said a favorable ruling for SCO in the Novell case could mean end-users would ultimately have to pay SCO a license fee, which could push up shares. On the other hand, both Kramer and Meeker, who have read the Novell contracts, said they believe SCO faces an "uphill battle" in the case. "The question of the rights SCO ended up with when it made its purchase from Novell is really a complicated question, because there's all this history around it in terms of AT&T's ( T) release of Unix as a proprietary product and before that as basically an open-source product, even though it was not called that," Meeker said. AT&T is the developer of the original Unix code, which it sold to Novell. "I think if you look into the facts that underlie what happened ... it is not difficult to draw the conclusion that SCO didn't buy anything worth anywhere near what it paid," Meeker added. A second motion to dismiss hearing in the Novell case has been scheduled for Jan. 20. The hearing could offer yet another clue whether SCO is on a death march or headed for a comeback.