VA Linux’s Bet: Turning Free Stuff Into Sales

Roughly two months after going public, (ANDN) sold out last Thursday. VA Linux Systems Inc. (LNUX) announced it was buying the Linux content network for $975 million in cash and stock (now valued at a little more than $800 million). Shares of VA
Linux fell 8-7/8 on Thursday to 128. Andover jumped 9-1/8, or 25 percent, to 45-1/8.

Does this deal make sense? Reporter@Large likes the marriage between
hardware (LNUX) and content (ANDN). VA Linux manufactures and sells
Linux compatible workstations and servers. Andover operates a network
of Web sites dedicated to Open Source/Linux users and developers. The
deal makes sense in a space where hardware delivers low margins and
advertising revenue will never support current Internet market
valuations. In addition, the core product, Linux software, is readily

Readily free!? The proverbial “show me the money (profits)” scares a
lot of Internet executives, but it’s an especially sensitive topic in
the Linux sector. Bob Young (CEO of Red Hat) and Larry Augustin (CEO of
VA Linux) have continually said that the money in this sector would come
from supporting and servicing both Linux hardware and software. VA’s move on Thursday made good on this notion and secured the company as the premier Linux destination for content, commerce, and services. In its S1
filing, VA Linux stated that it would have to sell services and support to
supplement sales. In other words, Larry Augustin had to prove to corporate America that not only should they buy his company’s machines, but they should also buy his company’s services.

Enter, a network of Web sites geared to open source
developers that delivers more than 50 percent of the Web’s total Linux
related traffic. Unlike Excite@Home’s (ATHM)
purchase of Blue Mountain Arts for roughly $1 billion, will
deliver certain value to VA’s existing business. Excite@Home bought Blue Mountain because of its strong user base, hoping that it will be able to monetize the users via advertising and ecommerce transactions. A high
price to pay for a fragmented demographic with no proven online purchasing
power (Blue Mountain Arts allows users to send and receive free online
greeting cards). Andover hosts “smart” traffic that if leveraged correctly,
could deliver awesome revenue streams to VA Linux. The user base and
knowledge posted throughout the Andover network (mostly at and will essentially become a source of information and
services for corporate Linux clients.

Pre-VA Linux, Andover’s goal was to create a critical mass of users,
which it has done, and then turn the network into a hub where buyers
(corporations) and sellers (vendors and developers) could meet. VA
Linux now takes that community and potentially becomes the vendor of
choice. Again, we’re talking about smart traffic here — WR Hambrecht +
reports that 68 percent of Andover’s visitors have direct involvement
technology purchase decisions for their employers, a majority of which
a tendency to purchase online.

By combing LNUX’s current properties and with
Andover’s network, VA Linux will control almost 2/3 of Linux related Web

traffic. The move to become the Yahoo! portal for the Linux space will
generate revenue through 1) ecommerce sales, 2) corporate services, and
advertising. Larry Augustin pointed to the announcement made two weeks
that Hewlett Packard’s Printer Division would utilize VA’s Linux related

products and services to make a case for the synergies between VA and

Only a week before the

VA Linux deal was announced, was
making acquisitions of its own. The company acquired,
an online support site for Linux, and Open Source with 1,500 registered
consultants. At QuestionExchange, customers post their questions to a
of experts. They then offer a fixed-fee for its solution or request
bids. Customers receive prices/bids back and then decide which
they will use to solve their particular problem. The site then utilizes
rating system where customers can evaluate and post each consultants
“score.” The problem, solution, and rating are all archived in
QuestionExchange’s knowledge base, which can be accessed by all
QuestionExchange customers. Call it the eBay of Linux information
services. . .this is just one example of how VA Linux will leverage and then

monetize Andover’s traffic, assets, and knowledge base.

In a research note published Jan. 5, I questioned the market’s
$180 per share/$7.1 billion valuation on VA Linux: I was bullish on the company’s management and market position, but
less than optimistic on LNUX’s revenue/earnings potential to support such a high valuation. The recent move is a positive for VA Linux, completing the necessary three pronged approach in the Linux space: 1) e-commerce, 2) corporate services and 3) advertising. At $122 per share with a $4.2 billion market cap, investors should be looking at a buying opportunity.

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