VA Linux an example of stellar IPOs gone south

In December, computer maker VA Linux set the record for the largest gain in stock price ever on the first day of trading. The company's stock, offered at $30 a share by the company, soared more than 697 percent to close at $239.25.

But VA has since seen its value drop by more than 50 percent. The stock declined further yesterday to close at $108.63, despite posting a second-quarter loss in line with Wall Street's expectations. In midday trading today, VA Linux was down about 2 percent to $106.25.

The turn of events can be seen as both a possible harbinger of circumspection about the future of the Linux operating system among investors, as well a cautionary example of market excess. All initial public offerings with the best first day gain have largely tanked since 1994, according to Richard Peterson, an IPO analyst with Thomson Financial Securities Data.

"It's been the mark of doom," he said.

Keith Bachman, an analyst with WR Hambrecht, said the "open-source" sector where Linux resides is extremely volatile.

"We're bullish on the sector, but part of the challenge is these companies were first to market. Investors couldn't get enough of these stocks and bid them up to interesting levels," Bachman said. "As more companies come to market, it will create an opportunity for more price stability."

Linux is a free operating system that has found a niche for server tasks such as managing Web sites or email. It was first developed by Linus Torvalds, at the time a Finnish graduate student.

VA Linux isn't the only such offering giving investors a hangover. Linux Web site developer Andover.Net, which VA Linux is buying, is trading far below its first-day IPO performance.

Shares of Andover.Net have lost more than a third of their value since the first day. By contrast, Red Hat, which develops Linux operating systems, and Cobalt Networks, a Linux server company, have managed to trade up or in close range to their first-day performance.

Despite the mix in results, analysts say Linux still resonates with investors.

With the growth of e-commerce, the popularity of the upstart OS is expected to grow as Web site owners load up on more hardware and networking equipment. Linux offers a way to cut costs.

"Two of the four deals in the sector have crapped out. But there's still a lot of hype in the (market)," said Jeff Hirschkorn, senior analyst with IPO.com. "This sector is rapidly evolving, and usually you see good results in these circumstances."

Because the software can be obtained for free, Linux companies are seeking out ancillary ways to make money. Red Hat plans to concentrate on services. While VA Linux has plans to move into services as well, it specializes in server computer sales and expects services will be only a tenth of its revenue by the end of 2001. When the "Linux" angle is scraped away, VA Linux is largely a computer maker competing against giants like IBM and Dell in a market where profit margins are slim.

Which strategy works best for the long haul depends on perspective. Red Hat has climbed nearly threefold since its IPO. The company closed at $26.03 on its first day of trading, adjusting for a 2-for-1 split. Yesterday it finished down $4.81, or about 7 percent, at $63.56. It was down about 2 percent in midday trading today.

Meanwhile, Cobalt Networks is down only slightly from its first-day close of $128.13. Cobalt yesterday ended the day at $100.50, down $3.75, or about 3.6 percent. The company's performance may be linked to the appeal of server appliances, special-purpose computers tailored to do a specific job faster and cheaper. Server appliance companies such as Network Appliance have generally had rising stock prices.

The question now is what happens with Linux-related companies such as Caldera Systems and Linuxcare, both of which are preparing for their public debut. Others like Lineo, CyberNet Systems, TurboLinux and SuSE are expected to file their IPO plans in the near future.

"These four deals all priced their IPOs above their range, so I don't think VA or Andover will effect future deals," Hirschkorn said. "What is key to the sector's future IPO performance is the market's overall tone."