Novell Jumps 21% on News of SUSE Linux Deal - TheStreet

Updated from 4:05 p.m. EDT

Novell

(NOVL)

shares shot up Tuesday after the networking-software company said it would buy SUSE Linux and receive a $50 million investment from

IBM

(IBM) - Get Report

.

Contrary to typical pressure faced by an acquiring company, shares of Novell soared 21.2%, or $1.28, to close at $7.33, in trading volume that was more than 13 times the stock's average. Shares of Linux competitor

Red Hat

(RHAT)

ended at $13.58, down $1.80, or 11.7%. IBM ended at $89.14, down 54 cents, or 0.6%. Shares of

SCO Group

(SCOX)

, which has sued IBM for allegedly misappropriating its Unix code in its Linux business, closed at $17.98, up $1.99, or 12.5%.

In a bold move that was not altogether surprising to Novell observers, the company said it would buy Germany-based privately held SUSE Linux for $210 million in cash, which is about five times trailing sales. The acquisition, expected to close by the end of January, builds on the open-source portfolio that Provo, Utah-based Novell started with the acquisition of Linux server and desktop provider Ximian in August.

The deal is expected to be accretive to earnings in fiscal-year 2005 and should have no impact in fiscal year 2004, management said on a conference call.

Novell also said IBM intends to make a $50 million investment in Novell convertible preferred stock. IBM and SUSE Linux also are negotiating extensions to the agreements between IBM and SUSE Linux for support of SUSE Linux on IBM products to provide product and marketing support arrangements for SUSE Linux.

Both moves give further legitimacy to the open-source Linux movement, analysts and observers said.

"This is probably good news for Novell and good news from the Linux perspective," said Meta Group analyst Earl Perkins. "Now, you have a recognizable name that is bringing essentially SUSE Linux and Red Hat more into the mainstream."

But "I think Red Hat and SCO are in trouble as a result of the announcement," Perkins added, because "you now have a player that is further up the food chain."

The acquisitions mean Novell will be able to offer a more complete "stack" of Linux products, starting from the operating system from SUSE Linux to desktop products from Ximian, with a worldwide sales and support team that includes between 20,000 and 30,000 channel partners. Novell also offers security and identity management products, services through the acquisition of Cambridge Technology Partners and application development technologies through another acquisition, of Silverstream.

"We will have big differentiation with regard to products that sit on top of the operating system," Novell Chairman and CEO Jack Messman said on a conference call.

Novell's purchase of SUSE Linux, the No. 2 Linux vendor after Red Hat, gives investors an opportunity to diversify Linux investments and give customers more choices, a money manager in Philadelphia said.

That could put pricing pressure on Red Hat and also slow down the company's sale cycles if potential customers decide to wait and see what Novell offers, he said. The SUSE Linux deal makes Red Hat look overvalued because its shares were trading at roughly 20 times trailing sales before the SUSE Linux acquisition was announced, the money manager noted.

The deals also appear to compromise agreements between Red Hat and IBM, Deutsche Bank analyst Brian Skiba said in a note Tuesday. Skiba called the Novell news "neutral-to-positive" for SCO because resolving the SCO issue could become more important as IBM's commitment to Linux appears as strong as ever. Skiba has a hold rating on Red Hat and buy rating on SCO, and his firm hasn't done banking with either company but has done business with Microsoft.

However, Novell executives indicated on the conference call that they believe SCO's legal challenge to Linux and the open source movement has little merit. In addition to its lawsuit against IBM, SCO has asked Linux users to pay license fees and threatened to sue Linux customers.

"We're not holding back because of SCO's undisputed or unsubstantiated claims," Messman said.

"Our customers are still demanding our products. They don't care about what SCO is saying so far," added Richard Seibt, CEO of SUSE Linux. "There is no decrease in demand. ... Because of the merger with Novell, I expect even higher demand in the near future."

As for Microsoft, which has cited Linux as a threat to its dominance on the operating system and desktop, the Novell news represents a "competitive threat," though that's in the early stages, said Drake Johnstone, an analyst with Davenport & Co., who has a buy rating on Novell. His firm hasn't done any banking with the company.

Johnstone said the deal also should help stabilize Novel's Netware revenue, which has been declining.

Netware, Novell's core product, was once the leading network operating system before being stepped on by Microsoft, the world's largest software maker, America's Growth Capital analyst Phil Rueppel wrote in a note initiating coverage of Novell last month. At that time, Rueppel said wrote that early successes in Linux "could place Novell at the top of only a handful of vendors who will be able to take advantage of what is expected to be an explosive market opportunity."

Rueppel does not have a rating on Novell but estimated its value at $6.66 a share and said he believes the company is poised to prosper over the next three to five years. His firm hasn't done any banking business with the company.