eMailbag Monday: Red Hat, Online Gambling, and the IPO Decay Curve

I would like to know what your outlook on Red Hat is. I’m from the Research
Triangle in North Carolina, and I have been watching this company develop
for a while. Now its blowing up on the Nasdaq. I would appreciate your
view.

–Dan Goldstein

Reply: I wrote about
Red Hat Inc. (RHAT
) in my debut column (
Throwing Its Hat Into the Ring). The company has the
highest market share in Linux shipments, is rapidly evolving its
www.redhat.com
site into a comprehensive Linux destination point, and has a
highly-experienced workforce (Red Hat is one of the oldest Linux
companies).

What’s more, the company has currency to make acquisitions and $73.30
million in its war chest.

Look at how Red Hat stacks-up against other software tool companies:

As is very clear, Red Hat looks very expensive, trading at a nose-bleed 543
times revenues. Such a state of affairs will likely not last long. First of
all, IPO success breeds lots of competition; that is, we will see a rash
of other Linux companies hit the market, taking attention away from Red
Hat. One of these prospects is LinuxCare, which is backed by the famed
VC firm Kleiner Perkins. Second,
Microsoft will not sit idly by and watch the Linux revolution destroy its
franchise, Windows NT. The giant from Redmond always likes a fight and the
company has the resources to carry it out.

Making a Bet on Starnet

Hello, what’s your opinion about SNMM? They are in the gambling/betting
industry on the Internet.

The Wall Street Journal has described Starnet as “one of the established
leaders in Internet gaming and entertainment.” IGWB Magazine described
Starnet as “the Home Shopping Network of Gambling.”

Gambling is predicted to be around a 10 billion industry by 2002. I
would think this is a low estimate considering e-commerce and other
estimates have always been sorta low? They plan on moving to the NASDAQ and
are profitable unlike most i-net stocks.

Thanks.

Reply: No doubt, online gambling is a high-growth industry and is
profitable.
Starnet Communications International Inc. (OTC BB:
SNMM)
has been a big beneficiary of this. The company has its own online casinos,
as well as consulting services to help other companies build their own
casinos (the revenue model consists of a set-up fee and monthly royalty
payments).

The company is based in Vancouver, Canada, and has operations in Antigua,
so as to protect itself from liability. What’s more, Starnet only licenses
its technology to companies outside of North America, where online gaming
is prohibited by criminal laws.

Despite all this, I have concerns. First of all, the OTC Bulletin market is
a loosely regulated market with many questionable companies. The track
record of companies successfully transitioning from OTC to NASDAQ is not
good. Second, Starnet does have a large amount of insider selling. Finally,
the legal implications of gambling online are not clear. Apparently, the
U.S. government is not particularly happy with such services and there could
be a backlash. This should scare away major investment bankers from taking
the company on as a client. The result will be low research coverage.

The IPO Decay Curve

Dear Tom, In your article about the IPO curve, you say that day traders
drive the stock into the stratosphere and then move on. Since the
institutions and big money guys are the only ones to get the IPO and the
IPO already opens in the stratosphere are you referring to them as day
traders. The small day trader seems to (after the ipo opens) to then drive
it up only 20% more if any. Why don’t you and other news agencies like CNBC
ever differentiate? It’s the institutions who are the Day Traders. I enjoy
your articles every day.


— Thanks, Tom M.

Reply: Here’s what I mean: Institutions/wealthy individuals get the
IPOs at the offering price. That is, they basically purchase these shares
the night before the offering. So these investors are not pushing up the
stock. On the next day, when the stock is issued on the market, there are
swarms of orders from investors. I would say lots of them are day traders
(those who look for quick in-and-out profits).

This has the effect of
spiking the stock on the opening, so the stock may be priced at $15 on the
night before and then opens at, say, $50, on the first trade. Then, the
institutions/wealthy people start flipping the stock, taking their big
gains and the short-term traders play the volatility and then usually get
out quickly. Although, in the case with Red Hat, there was lots of
carry-through on the IPO — as the stock continued to soar for several
days.

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