Novell's Fight for Respect

In many ways, Novell is a lot like many other midsize software companies. All are struggling to reinvent themselves in a world where big deals are being won mainly by the likes of Oracle (ORCL), IBM (IBM) and SAP (SAP) -- and where business models are being upended by such trends as open source and so-called "software as a service," where vendors make wares accessible over the Internet and rely more on monthly subscriptions than up-front license fees.

But Novell has had a key advantage over its peers. In 2003, it acquired Germany's Suse Linux, then second only to Red Hat (RHAT) in supporting and installing Linux, the free operating system that runs on more than a quarter of the world's servers and is slowly making inroads on desktops and other areas. As evidence of how hot this market is, Red Hat's stock has more than doubled in the past year. Even Oracle Chief Executive Larry Ellison says he's considering a jump into Linux (see BW Online, 02/09/06, "Oracle's Open-Source Shopping Spree ").

The problem for Novell, though, is that the company is having a hard time capitalizing on the Linux buzz (see BW Online, 10/31/05, "Cold Realities for Novell"). Recent share price gains have been all but erased, in part due to a 15% rout on June 1, the day after Novell announced second-quarter earnings. Analysts cited a lack of urgency on the part of Novell Chief Executive Jack Messman. Credit Suisse First Boston's Jason Maynard, a vocal critic of Messman, downgraded the stock from outperform to neutral, saying Novell had lost its chance to become a strong No. 2 in Linux.

It's not that Messman has been sitting on his hands. He's instituted a $200 million share buyback, is cutting jobs, and on May 24 announced the sale of the company's consulting division Celerant -- all moves clamored for by investors. Another important move by Messman: He promoted Ron Hovsepian to president. Many on Wall Street reckon iHovsepian has the wherewithal to force much-needed changes in a company still viewed by many as too lackadaisical. reporter Sarah Lacy spoke with Hovsepian after last week's sell-off. Edited excerpts of the conversation follow.

Were you surprised at the harsh reaction to earnings news?

Yes, I was surprised. I don't quite understand it. We were right in the lines of what we told them what our revenue and earnings (would be). I do understand their frustration in part, but I am a little confused by the fact that we told them what was going to happen and they agreed. Then we did that, and the whole place went nuts on us. I have to admit I was disappointed. But I understand they are our owners, and we still have to prove ourselves to them.

What is it about Novell? It never seems to get the benefit of the doubt on Wall Street?

I don't think we've earned that right. In the past five to six years, the company has not delivered, and it has made a lot of promises. I have been manically focused on delivering. I told them what we'd do first quarter, and we delivered on that. I told them on the second quarter, and we delivered on that. I would have liked it to be more on both quarters, but I am on a path with this team to deliver on commitments. It's really important to build up that credibility over time. Until they see a trend of three or four quarters where we deliver on what we said we'd get done, I don't think we've earned the right yet.

Are things at Novell better than it appears from the outside?

Absolutely. Our core Linux business grew 20% quarter-over-quarter. Why? Our strategy is different than Red Hat's. They are approaching this as an edge server play, and it's an enterprise play. [In other words, Novell sells Linux as part of large company-wide deals, not just to run on individual servers.] We are making extra investments in Linux on the desktop and [products for retail] point of sale and banking that we think are going to be very successful. Desktop revenue grew 100% last quarter. Granted it's still a small sub segment. Customers want to buy an enterprise story [that includes] servers, desktops, and all those pieces. We are focusing the company on building that strategy. Target (TGT) picked us over Red Hat, and they picked us because we had an enterprise story.

What about Red Hat? They had a great run last year, then surprised and delighted analysts again by doing the gutsy acquisition of Jboss (see BW Online, 04/11/06, "Red Hat's Red-Hot Deal"). How does that affect you?

I think it'll have a positive impact on us, but that will be seen over time. We've really focused on what we do well: dealing with mixed environments (where there's Linux and traditional software). What Red Hat did (when it bought Jboss) was poke IBM and Oracle right in the eye and said: "We're going to go after this application server market."

Are more cost cuts coming?

I'll put it this way: I think we can be more productive as an organization. Productivity is the mantra. This lines up with our commitment to have 12%-15% operating margins by the end of 2008. We've made good progress in the second quarter. We went from negative $3.9 million in core operating income in the second quarter of 2005 to positive $1.6 million in core operating income in the second quarter of 2006.

You've got a big release coming up in July: the new version of desktop Linux software. What can you tell us about that market?

There are three key things (when it comes to desktop Linux). It's a great value -- it's one-tenth of the list price of Microsoft (MSFT) desktop. Second, there's great functionality here, in terms of the innovation that has occurred with a very small team and a big open source community. It's a great testament to the open-source movement. Then, [it's] back to the mixed environment. We've got to be realistic. It's going to be a mixed world, and our Linux systems have to connect. We've designed a number of things taking that into consideration.

What about Ellison's comments that Oracle may get into the Linux game? (Shares of Red Hat declined in the wake of his recent comments).

It was fascinating from the point of view of the impact they bring to the marketplace; what he can do with just one comment. On the flip side, there's lot to build when you enter into this marketplace. A lot [to do] around the community.

Just to say you're going to get in the market is one thing; to actually do it takes a period of time. They're very capable of doing it. The question is: What's the value [for customers]? The biggest concern to the market is: Is this Oracle trying to fragment the Linux market? That's the last thing we need. Red Hat and ourselves work closely with Open Source Development Labs [the nonprofit that governs Linux)]to make sure we stay in harmony with what's coming out in the new [versions of Linux]. Unique things from Oracle are not good for the market. That's just handing the operating system market to Microsoft.

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