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THE DAY AHEAD: Linux stocks go from famous to forgotten

Where have all those highfalutin Linux stocks gone?

Linux stocks have gone from famous to forgotten in just a few months despite evidence that the open-source operating system is gaining momentum. Investors loved Linux stocks when they were young and unproven. Now Linux companies are sounding like grownups and delivering good quarters, Wall Street can't stop yawning.

Linux stocks: Time to buy?

Wall Street is prone to overreaction -- in both directions. When a hot growth market appears, Wall Street hops on the bandwagon -- sometimes years ahead of any fundamental evidence. As investors move on to something new, the previous buzz is forgotten.

Despite Thursday's gains, Red Hat (Nasdaq: RHAT) is hovering around 52-week lows. VA Linux (Nasdaq: LNUX) reports strong third quarter results and shares barely budge. Granted, we're in a bear market, but Linux stocks are taking a lot of abuse these days.

It's very frustrating for Linux fans, especially the ones who bought Linux stocks at 52-week highs. If you're holding shares of Red Hat, VA Linux or Caldera Systems (Nasdaq: CALD), you have to be wondering when the real market valuations will stand up.

Is Red Hat worth its 52-week split adjusted high of 151, or its current 17 or so? Is VA Linux worth its high of 320 a share or its current price around 43? Caldera hit a high of 33 and is now near its low since going public. Should companies selling free software even be allowed to go public? The truth is probably somewhere in the middle.

We're not going to tell you it's time to buy Linux stocks, but there's a serious disconnect between Linux reality and Wall Street.

In recent days, Linux fans have had a lot to cheer about.

We'll start with the latest. VA Linux reported a strong third quarter that easily beat Wall Street estimates and topped the most optimistic sales expectations. VA Linux got a little pop on Wednesday and Thursday, but still can't live up to its record first-day IPO gains.

VA Linux chief Larry Augustin gave a bullish outlook. Revenue was up 71 percent sequentially, and officials said the company could keep up the growth. Augustin also said VA Linux could grow as long as its Internet-centric clients grow. VA Linux could be sitting on top of an annuity-like revenue stream. The company also has $125 million in cash to cushion a market downturn. It only burned through $2 million in its latest quarter.

Analysts cheered the news and projected a profit in the second half of 2001. Traders were mixed at best.

But don't let market sentiment hide the fact that the open source Linux platform is gaining traction. If it does, Red Hat, VA Linux and other Linux companies should do well. The following recent Linux news would have juiced Linux stocks just a few months ago:

  • Silicon Graphics (NYSE: SGI) launched a Linux graphics station.

  • VA Linux outlined plans for a Intel-based system. Red Hat is also spearheading Linux development on Intel's latest chip. Compaq (NYSE: CPQ), Hewlett-Packard (NYSE: HWP), IBM (NYSE: IBM) and Dell (Nasdaq: DELL) are also on the bandwagon.

  • Dell said it sees Linux systems representing about 2 percent to 4 percent of its shipments in upcoming quarters. Dell is partnered with Red Hat.

  • Red Hat outlined some real five-year financial targets. The company projects 100 percent annual revenue growth and $1.36 billion in fiscal 2005 revenue. The company sees a long-term gross margin of 70 percent, which would be a vast improvement over fiscal 2000's 46 percent.

    And Augustin said Linux will gain even more momentum as it evolves on Intel's (Nasdaq: INTC) new architecture. "We're seeing a significant buildout," said Augustin. "As Intel's new architecture scales, Linux will scale with it."

    That's a lot of good news -- shame Wall Street doesn't want to hear it.

    • 2HRS2GO: VA Linux chief takes stock gyrations in stride
    • VA Linux tops 3Q estimates, bullish on future
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