Linux vs. Unix Values Evident in Red Hat, Sun Market Valuations

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Let’s take a look at Sun Microsystems, the once mighty Unix vendor and maker of servers that powered the Internet, circa 1982. And Red Hat, a company that’s been purveying Linux software since 1995. Sun sells more than $13 billion of goods and services per year, while Red Hat sells a little over $600 million. So which is worth more?

Ask the market (and remember the market is not stupid, at least not in the long term), and the answer is that they’re both worth about the same: Both companies are currently valued by the market at about $2.7 billion. (Actually Red Hat is worth more than Sun today — which is a story in itself.) Sun’s value has been dropping like a stone over the past few months, while Red Hat’s has been soaring — almost doubling since mid-November. Today it’s up almost 2.5 percent.

There are a number of reasons for Sun’s declining share price that have been widely discussed. It’s not clear where Sun is going to make money in the future, in particular how or whether it will monetize its open source software and whether open source developers will drive sales for its systems and services. There’s probably also a feeling on the part of the market that Unix is not “where it’s happening.” Since Sun has cash reserves of roughly the same as its market valuation, the market is essentially valuing the entire Sun business at nothing.

But more interesting by far is the fact that the market values Red Hat — a Linux company with revenues of $600 million — at almost $3 billion in the current economic and market conditions. Why it is valuing Red Hat at this figure is also interesting.

Sun’s cash reserves give its shares an underlying value, which explains why the company might be worth what it is even if you value the business itself at nothing. But Red Hat has far less cash: about $1 billion at the last count. Adding in other assets doesn’t come close to $2.7 billion — the company is not being valued on an asset basis. And Red Hat pays no dividend (and isn’t a mature business like an oil company anyway), so it can’t be valued as a yield stock.

That leaves valuation on an earnings basis. The company’s earnings per share (EPS) on a historic (ttm) basis is about 41 cents. With the share price standing at $14.98, that puts the Red Hat on a price/earnings (P/E) ratio of 35.84. Which is very high indeed in the current market climate.

An uncommonly high P/E ratio might mean that the market has very high hopes for Linux in general, and Red Hat in particular. And that might make sense in the current economic climate. With tough trading conditions and sales plummeting for many businesses, open-source software sounds mighty attractive (without going in to the features and benefits and the whole cost of ownership thing). When markets get an idea in their head, money tends to flock to the obvious stocks — and Red Hat is arguably the brand in enterprise Linux. A P/E of 35 would then imply that the market expects some serious earnings growth from Red Hat — and perhaps Linux more generally — in the foreseeable future.

There’s another possibility of course. In contrast to Sun, the market might be expecting someone to come in and make a bid for Red Hat. After all, it’s Linux, not Unix, that the market seems to fancy at the moment.

Who might buy Red Hat is a game that can be played endlessly, and just about everyone who is anyone has been mentioned in the past — Microsoft, Dell, Google, Oracle, you name it. So what about another name that’s been mentioned less frequently in the past: Sun? Much of Red Hat’s business is selling support services for open source software, which is an activity Sun would like to be doing more of. Sun’s pretty much got the cash, and such a move might get its share price moving north again.

OK, so it’s not really that simple, and historically the two companies haven’t been the best of friends, but then who’d have thunk Microsoft would invest in Apple (to the tune of $150 million) back in 1997?

Ah, yes, Apple. Now there’s a company with the best part of $25 billion in the bank. I wonder if it is planning to spend any of that cash while Steve Jobs isn’t around? It could buy Sun and Red Hat if it wanted to, and establish itself in the enterprise marketplace without even breaking its stride. Now there’s a thought that puts the relative value of some well known names into perspective.

Paul Rubens is an IT consultant and journalist based in Marlow on
Thames, England. He has been programming, tinkering and generally
sitting in front of computer screens since his first encounter with a
DEC PDP-11 in 1979.

This article was first published on ServerWatch.com.