The effects of open source on stock prices

Has open source been positive or negative for its primary (commercial) proponents? That's the question I asked myself yesterday about Red Hat, Sun, and Novell, and found the answer interesting. I looked at these three as they, more than any others, have results that can be isolated and directly attributed to open source. A company like IBM does a lot with open source, but it's harder to discern the effects on the company's stock price because its embrace of open source is less pronounced/distinct among its other corporate policies.

A quick review of the data suggests that the market largely bought into the early hype on the transformative power of open source, but has taken a cautious "wait-and-see" approach since the initial euphoria.

Take a look at Novell's stock price since 2003:

Novell announced its Ximian acquisition in August 2003, and then the SUSE acquisition in November 2003. In the process, its stock price shot from $2 per share to over $12 per share. Clearly, Wall Street liked the resurrection-through-open-source story.By mid-2004, however, Novell's stock price settled into the $6 to $8 per share range that it has maintained for the past four years. Analysts have waited for Novell's Linux and open-source story to fully materialize. Despite Novell's hype on the importance of its November 2006 patent agreement with Microsoft, the agreement has had no lasting impact on the value of the company. It helped to lift Novell's stock price in 2007...only to see it crumble back to the too-familiar $6 per share level.

My own personal belief is that Wall Street was right to buy into Novell's original ambition to "bet the company" on open source. I was there. I remember it well. Chris Stone, Carl Ledbetter, and the other Novell executives absolutely bought into that vision. Now Novell's current management needs to buy into it, too, as it once did.

Novell's ambitions relative to open source have become stunted over time (though its ability to execute has arguably improved in key ways). It's not too late for the company to embrace the future: ambition coupled with execution.

But what about Red Hat and Sun? Have they benefited from open source?

Red Hat is easy: all it does is open source, so its stock price largely reflects Wall Street's overall belief in open source, along with a more narrow reaction to Red Hat's ability to monetize it:

Red Hat's stock performance is fascinating. As its ambition has grown, demonstrated by the announcement of the acquisition of JBoss in April 2006, Red Hat's stock price has trended downward. The company's stock price benefited from Novell's entry into the market in 2003, then plummeted as investors started to question how much steam open source could inject into Red Hat's growth engine.

But take a look at all the announcements from Red Hat in 2005. It achieves a #1 ranking in CIO Insight's vendor value survey ("Oh, maybe there's something to this open-source thing"), and announces a series of other things.

But the real driver of Red Hat's stock price was consistently good earnings. "Yes, we can" said the earnings, over and over and over again. Those earnings continued, but in April 2006 Red Hat announced its intention to acquire JBoss and the market responded, "No, you can't." Its stock plunged. All the good news of 2006 didn't restore the market's confidence in Red Hat.

For Red Hat at this point, it's no longer a matter of telling a good open-source story. The market wants delivery. It's very likely that we'll see another run-up in its stock price in 2008 (to match the run in 2005) if Red Hat can simply execute on its JBoss vision. 2005 was the year of rewards for its performance with Linux; 2008 will be the year of rewards for its performance with middleware.

What about Sun? Sun's situation in 2008 is very similar to Novell's in 2004/05. Sun has been rumbling around open source for several years, but the definitive move forward came with Jonathan Schwartz taking the helm in April 2006.

Here's how the stock has performed since 2003:

Are you noticing the trend? The market gave Sun early kudos for its aggressive open-source plans, and then again in August 2007 when it announced it was cutting jobs (and distributing StarOffice through Google), but has cooled toward Sun's stock as it awaits execution against the vision.

Sun took its boldest step yet with the acquisition of MySQL in January 2008. The market, however, has not returned the favor. The "honeymoon" period for open-source hype gets shorter and shorter every year. Novell got a year of stock growth out of its open-source story. Sun got half that. It will be when Sun starts to truly execute against its open-source ambition that the market will reward it.

Lessons? With Novell and Sun, in particular, Wall Street has applauded bold proclamations around open source, but is now waiting for execution. With Red Hat it's much the same, but I think there's a latent belief that Red Hat has done well with execution...but poor with ambition. In the case of JBoss, it hasn't yet seen a reward in its stock price in part because it fumbled early execution on integration, but seems to have put those early foibles behind it.

We'll see. Indeed, that is the clear message from the market: "I like the idea, now show me that it works, and not just for commodifying stodgy old markets." With open source largely powering much more profitable businesses like Google, this is a fair request.

We should continue to promulgate the open-source vision, but we can't expect that noise to carry far anymore without execution. Wall Street's patience for open-source fiction gets shorter each quarter. It's increasingly shopping in the nonfiction section of the bookstore.

The good news is that Novell is starting to see its Linux business bear fruit. The same holds true for Red Hat with its JBoss middleware story. With Sun the story is more complex because it is dwarfed by hardware, but it has been profitable - if barely - since it got into open source.

But if these three companies can demonstrate sustained, exciting growth with open source, I suspect it won't be long before Wall Street clamors for more open-source success stories to flood the markets. Time to get (back) to work!