AOL denies bidding for Red Hat

On Saturday, The Washington Post reported that the media giant was near to cutting a deal with Durham, N.C.-based Red Hat in a competitive strike against Microsoft.

"The Washington Post story is incorrect," said AOL Time Warner spokesman Andrew Weinstein. "AOL is not in negotiations with Red Hat."

A representative for Red Hat declined to comment.

Even if the two companies are not considering a merger, AOL Timer Warner could license Red Hat Linux for use on PCs or other devices in conjunction with its online service. The AOL service currently is available only for Windows and the Macintosh, although the Netscape browser supports Linux. AOL currently has a Linux licensing deal with Red Hat for one of its Internet devices.

Financial analysts expressed their reservations about the possibility of an acquisition, suggesting instead that a strategic relationship makes more sense.

In a research note titled "RHAT Bought by AOL? Before or After Space Aliens Bear Elvis' Love Child?" MacDonald Investments analyst Brent Williams on Tuesday described the a merger as "extremely unlikely."

Merrill Lynch analyst Peter Von Schilling offered a similar assessment.

"AOL buying (Red Hat) seems unlikely, in our view," he wrote in a Tuesday research note. "But we think there could be a strategic partnership/customer deal brewing" for Linux on Intel-based Web servers, the Netscape browser or embedded operating systems, or as a straightforward strategic investment, he said.

Linux is a popular Unix derivative developed in 1991 by Linus Torvalds. Like Windows, Linux runs on Intel-based PCs, but it uses a different licensing mechanism. While Microsoft controls the source code to Windows and charges a fee for every copy sold on PCs, Linux uses an "open source" model through which companies have the right to install as many copies of the operating system as they wish.

On the surface, competing with Microsoft in the operating system market would seem to make sense, especially as AOL Time Warner increasingly knocks heads with the software giant in the market for Web services used on the desktop.

Gartner predicts that next year 80 percent of companies developing software such as operating systems will support Web services architectures.

But Linux, which has some traction in the server market, has negligible share in the desktop market, making the acquisition of a company like Red Hat a potentially losing strategy, analysts warn.

AOL, in fact, has tried twice to bring out Linux desktops. In 2000, AOL and Gateway touted the Touch Pad, a Web-surfing appliance with a Transmeta processor. Four months later, Gateway stopped promoting it. And AOL Avant, a joint venture in Spain, also has promoted the Dot.Station, an Internet-surfing terminal from Intel. Dot.Stations did reach consumers, but the project has since been de-emphasized.

"Since AOL's real strength is in content creation and delivery--both on the AOL side and the Time Warner publishing and cable operations--we think AOL's real strategy is to make the operating system irrelevant," Williams wrote. He also described as "patently absurd" the idea that consumers or businesses would replace Windows simply because AOL Time Warner bundled its online service with Linux.

Microsoft's dominance in desktop applications, such as word processors and spreadsheets, and the small number of Linux games, are other strong reasons that "we do not think that customers would want to take the risk" to switch to AOL/Linux from Windows, Williams emphasized.

"Linux in the desktop market in the U.S. is basically a non-starter," said Chris LeTocq, industry strategist with Sage Circle. "The applications in the U.S. apart from servers tend to be OEM set-top boxes. For desktop or set-box use in the U.S., it makes more sense to get an OEM license. There's no need to purchase a company that's in the distribution services business."

Outside the United States is "another story," LeTocq said.

A Linux OS and online service package could be sold for much less than Windows if the package were based on AOL's monthly billing plan, as the Windows licensing plan is more expensive.

"A desktop vendor in Latin America or especially China, if they can save 50 to 60 bucks on a PC, that's a big deal," LeTocq said. "It's conceivable that a Linux alliance with a media company could work in that environment."

Even if AOL Time Warner does nothing with Red Hat, Williams emphasized that the Linux company is in a strong position.

"We strongly believe Linux is for real and that (Red Hat) is the quality name to own to take advantage of Linux's momentum," he wrote. But he noted that he had rated the company as a "hold" as it "begins to develop momentum in its Unix-to-Linux consulting business and stabilizes the fluctuations in the embedded systems group that have been driven by the ebbing fortunes of its device manufacturer client base."

Knocking heads
The merger rumors come as competition intensifies between AOL Time Warner and Microsoft. Earlier this month, for example, the media conglomerate responded to Microsoft's .Net Alerts service by launching AOL Alerts. Both services use instant messaging to deliver custom stock quotes, auction updates or other information to computers, handhelds and cell phones, among other devices.

The companies started knocking heads openly last summer, when negotiations collapsed over how to include a version of AOL software with Windows XP. AOL Time Warner responded by cutting separate deals with PC makers that ensured desktop placement alongside Microsoft's MSN.

As the number of AOL subscribers has increased, MSN has added members more slowly. AOL subscribers swelled from 9 million in fall 1997 to 33 million at the beginning of this year. In December alone, AOL gained 1.9 million new subscribers, the company said. MSN, by contrast, floundered for years, going from 2.5 million subscribers in 1997 to 7.7 million in December.

But the AOL service is largely dependent on Windows, where Microsoft increasingly leverages its monopoly operating system against AOL Time Warner.

Windows XP, for example, has multiple hooks--messaging, media playback, online authentication and photo processing, among others--that tie back to MSN.

"Microsoft has a clear advantage with Windows XP and driving traffic to MSN," said Gartner analyst Michael Silver. "It's the foundation for their Web services strategy."

In the future, Microsoft plans to offer paid services through its MSN Web site, some of which are expected to require use of the online service component. Like AOL, Microsoft already charges a monthly fee for MSN online access, something it is expected to do with MSN Web services leveraged off the desktop.

From this perspective, AOL Time Warner could benefit from a Linux deal, particularly as Microsoft sees some real gains from its desktop-tied-to-the-Web strategy.

Internet Explorer, which is integrated into Windows XP and available separately for older Microsoft operating systems, is a good example. Internet Explorer 6 replaces the more typical "page not found" with an MSN search page. That tactic helped Microsoft claim that MSN had beat out Yahoo for Internet searches during November.

But market researcher Jupiter Media Metrix, which tabulated the data, concluded the "page not found" redirections accounted for about half of the MSN searches. MSN search pages led Yahoo 36.6 million to 31.9 million visitors in November, according to Media Metrix.

"If you look at how much traffic the auto-search redirection generated from MSN, it's almost 50 percent," said Media Metrix analyst Michael Gartenberg. "That's a huge number they essentially picked up for free by being the default."

Whether AOL is looking at Linux or not, the company must find a way to neutralize Microsoft's desktop advantage, analysts say.

"As long as Microsoft can drive services off the desktop, they're going to have an advantage over AOL," Silver said.