MontaVista's Uncertain View

This startup, which embeds Linux in consumer electronics, is poised for big growth and maybe an IPO -- if Wind River doesn't spoil the party

by Sarah Lacy

Jim Ready, CEO of closely held software maker MontaVista Software, started off 2006 relaxed from a Hawaiian vacation and espousing an upbeat outlook. His company, which specializes in code that's "embedded" in consumer electronics and other gear, was entering its seventh year. And Ready was confident that in 2006 MontaVista would turn profitable and possibly move closer to an oft-rumored IPO. "When we started this company, we knew this would change the embedded computing world, and that has happened at a pretty good clip," Ready says.

Bold words for a man who's currently undergoing a search for his replacement, has recently accepted the resignation of his marketing chief, and is in the midst of a restructuring that calls for an undisclosed reduction in staff. None of that is uncommon in the rough-and-tumble world of emerging tech companies. But Sunnyvale, (Calif.)-based MontaVista has a reputation for results that don't quite live up to outsize goals. And as rival Wind River Systems (WIND) begins treading on MontaVista's turf, pressure on Ready and his team to make good on promises has never been greater.

ANOTHER RED HAT?

At stake: how big a slice of the $1.5 billion embedded-software market will end up with MontaVista, which has hitched its fortunes to Linux, the low-cost operating system that's updated by developers around the world via the Internet. Ready's model is Red Hat (RHAT). Just as Red Hat sells and supports Linux for companies, MontaVista develops and supports a version of Linux that's sold to engineers working on a vast array of manufactured products, from phones and to telecom equipment to cars and other consumer devices.

It's not hard to see why MontaVista -- or any other budding open-source company -- would emulate Red Hat. Sales at Raleigh (N.C.)-based Red Hat jumped 44%, to $73.1 million, in its fiscal third quarter, which ended in December. Net income more than doubled, to $23.2 million, in the same period. But Red Hat is the exception -- not the rule -- among open-source players.

MontaVista wants to change that. The market for embedded software is poised to boom. Currently, many would-be customers write their own code in-house. But that can be costly. And a growing number of manufacturers would rather rely on a standardized operating system, freeing engineers to focus on the concepts that can really distinguish a product, such as design and layout. MontaVista and Alameda (Calif.)-based Wind River both reckon the embedded market could become as big as $5 billion a year over time.

BIG OPPORTUNITY.

And Linux has obvious benefits. For one, it's often cheaper than proprietary alternatives. Also, manufacturers don't want to be locked into an operating system over which they have little control. Nor do they want to be beholden to any one vendor, as many computers makers are with Microsoft (MSFT) and its Windows operating system.

Little wonder that Linux is finding its way into more devices. Motorola (MOT), Samsung, and Panasonic have all introduced Linux smart phones (see BW Online, 11/8/05, "Linux Answers Phone Makers' Call"). The Open Source Development Labs has embarked on several projects to standardize Linux for wireless handsets and telecom gear.

It has the makings of a big opportunity. When Ready was getting started in 1999, using Linux for devices was a radical idea. John Shoch of Alloy Ventures remembers getting the call in 1999 when Ready first proposed an embedded Linux company. It hadn't even occurred to Shoch, though he had made several investments in embedded software.

"I wish I'd thought of putting those two words together," Shoch says of "embedded" and "Linux." "On the spot we shook hands [on an investment deal].