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Redhat: Open Opportunity for Investors?

Wasn't open source supposed to be the next best thing? Well, as of now, it looks like investors think it is one of the worst things.

Actually, open source is not a new phenomenon. It has been a critical part of software development for many years. It was the brilliant Linus Torvalds, a Finnish student, who helped catalyze the open source movement when he launched his Linux operating system in the early 1990s. Torvalds had faith in the concept of "power in numbers"; that is, allow the programmers of the world to unite and collaborate on the development of the Linux operating system.

So far, it has been a wild success. There are now a variety of public companies that cater to the Linux market, such as Corel, VA Linux, and Red Hat.

Of course, all these stocks are now selling at fractions of their values from last year. Even the leading light in the industry, RedHat (RHAT), has been punished severely.

The putative demise of Linux has -- to say the least -- been greatly exaggerated. Actually, there are no signs the market adoption is slowing. Linux shipments grew faster than any other server operating system over the past two years (yes, even faster than the monopolistic Microsoft). Research shows that in 1999, Linux shipments dominated 24.6 percent of the server operating system market, up from 15.8 in 1998.

Critical to the success of Linux is supporting the global community of smart programmers. This is where Red Hat has been successful, as it has facilitated the growth curve of the market acceptance of Linux.

Because Linux is evolving, this makes it the perfect operating system for the Web, which is also constantly changing. What's more, Linux is extremely cheap (you can download it for free). This makes it easier to implement this in Net appliances, handheld devices and thin clients.

The big question is: How can companies, such as Red Hat, make money from the Linux wave. Simply put, Red Hat is becoming the trusted source of technical support for Linux. For this, companies will gladly pay fees.

So far, it is working. Last year, Red Hat's revenue rose to $42.4 million, 28 percent above last year's sales. Net losses for the quarter hit $24.5 million, or $0.17 per share. For the year, they lost $0.40 per share. The company has $242 million in the bank, which is enough to last the company for some time.

Their total enterprise customers rose to 140 compared to 60 last quarter, including Home Depot (NYSE: HD) and Cisco Systems (Nasdaq: CSCO).

When Red Hat's stock was selling at nosebleed levels, the company bought a variety of companies, such as Cygnus Solutions and Hell's Kitchen Systems (both deals were completed in January). Most importantly, Red Hat has been leveraging its Linux leadership into the enterprise market, such as with the introduction of its Enterprise Solutions, which allows for integration with Oracle 8i and optimization for SAP's R/3.

Expect the momentum to continue. And once rationality returns to Net stocks, there should be lots of upside with Red Hat.


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