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How Can Investors Jump on the Linux Locomotive? Right now, it isn't easy. But as the free-software movement evolves, public companies will emerge References to the term "paradigm shift" were numerous on street corners and in bistros of San Jose during the first week of March. That's nothing new in a town where computer industry buzzwords are as common as palm trees and bad post-modern architecture. But to many of the 12,000 programmers, entrepreneurs, and curiosity seekers who attended the three-day Linux World trade show here, the term was an expression of fear -- an emotion that Silicon Valley people don't usually display so openly. What's so scary? Free software, that's what. The software is Linux, the first fully functioning operating system that's available just for the asking. As the geek community likes to say, that's free as in free speech, not free beer. In other words, the source code of Linux is available to anyone who wants to fiddle with it. That's the opposite of the traditional proprietary model of software development, where companies guard their source code zealously and charge a big fee to anyone who wants to take a peek. Which raises the question: How do you make money on a product that's free? If the paradigm has indeed shifted in favor of Linux-type software development, a lot of money won't be made in Silicon Valley, not to mention Redmond, Wash. "Everyone keeps asking me what the ticker symbol of Linux is," laughs Larry Augustin, the CEO of VA Research, one of the leading Linux startups. The joke is at the expense of Wall Street, which isn't laughing. STUMPED. There are, of course, ways of making money on free software. Just look at Netscape, which recently sold itself to America Online (AOL) for more than $4 billion and whose main product, the Navigator browser, has always been free for downloading from the Net. The question that stumps investors -- including venture capitalists and individuals who are keeping an eye out for future initial public offerings -- is how much money can be made from Linux, and what is the best way to make it? To better understand the answer to that, consider the history of Linux. It's an outgrowth of the Unix operating system designed by Bell Labs engineers at AT&T in the early 1970s. Unix was also meant to be an open-source program, but Ma Bell's lawyers didn't close an important loophole: Once someone got the original source code from AT&T, they could alter it and then make the changed version of the program proprietary. As a result, Unix developed into dozens of different, competing operating systems, most of them owned by high-tech giants such as IBM, Hewlett-Packard, and Sun Microsystems. Then in 1991, a graduate student in Finland named Linus Torvalds developed his own operating system kernel based on Unix -- which soon came to be known as Linux. But the license for Linux was significantly different from Unix' license. It states that anyone can take the Linux source code and change it. But any changes must be made available to the public for free and cannot be reincorporated into Linux. Torvalds retained control over the official release of a stable version of the operating system, which changes every 30 months or so. But the developers' version of the operating system -- the software that controls a computer's basic operations -- is constantly changing and evolving. BUG-FREE. Today, thousands of programmers are working on improving Linux' source code. As a result, in the eight years since its birth, Linux has evolved into what is widely acknowledged as one of the most bug-free and flexible operating systems around. Installations of Linux -- on servers, workstations, and even desktop PCs -- more than tripled in 1998 to nearly 750,000. That number is expected to grow even faster this year. No one received any money for the source code for those 750,000 installations. But that doesn't mean that no money changed hands. Companies spent millions on service and support from Linux vendors. They spent millions more on hardware that was specially designed to make the most of Linux. Startups such as Red Hat and S.u.s.e are distributing Linux CDs at a slight markup to the cost of burning a CD and shrink-wrapping it in a cardboard box. Another company, Caldera Systems, which refers to itself as "Linux with a tie," is selling itself as a full-service distributor and consultant to large corporations that specialize in integrating Linux into enterprise software systems such as SAP's resource management program and Oracle's database. Yet another company, called LinuxCare, is betting that providing technical support is the way to make money from Linux. It offers phone support 24 hours a day, seven days a week to corporations that buy its service package. VA Research, by contrast, hopes to profit by selling specially designed servers with Linux preinstalled on them. CATCHING ON. None of these companies are public yet. The only public company whose fortunes are directly tied to Linux is tiny Applix (APLX), which makes office-productivity software, including a word processor and spreadsheet for Linux. Applix' stock is selling around $4 a share, a figure that doesn't sound large but still gives the company a 1999 price-earnings ratio of 36.6, which is high for a software company. Don't expect Applix to be alone on the public markets for long. All the major Linux companies listed above have significant venture capital backing and major contracts with industry giants, from Intel (INTC) to Compaq (CPQ) to IBM (IBM). Those early investors can expect to get a sweet repayment, since initial public offerings of some of these companies are rumored to be imminent. Not that the VC funding was easy to get. LinuxCare CEO Arthur Tyde was turned down several times before finally getting backing: "The first thing that every potential investor asked was: 'You mean you're going to invent something and then give it away? How are you going to make money without owning any intellectual capital?'" Venture capitalists seem to be getting the hang of it, however. Representatives of several prominent firms showed up at the Linux World show, although none was willing to comment on what they were doing there. They were easy to spot though -- they were the ones wearing suits and ties. Indeed, conference looked more like a reunion of Grateful Dead concert-goers than a trade show. Dr. Seuss hats and tie-dyed T-shirts were more evident than PalmPilots and business cards. But you can bet that suits will be more in style at next year's meeting. And chances are that the word Linux will be mentioned in more than one IPO filing by then.
Jaffe writes about the markets for Business Week Online
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