It's been some time since I touched on Novell, a leader in PC networking in small and midsize businesses through its flagship product, NetWare.
Unfortunately, NetWare has been a slowly declining cash-flow franchise. A new version, NetWare 7.0, should be out by year's end, and that might help stem the tide in the short term but does little to resolve the declining long-term fortunes for this once-dominant company. This is where Novell's new Linux strategy comes in.
Anyone who visits the company's Web site will see the prominent display of its two leading Linux initiatives: Ximian and SuSE. We know that the open-source/Linux community is making large inroads into corporate IT. Linux is not only reliable, stable, and scalable, but it can have real advantages over Windows and Unix, including cost and ease of customization. For example, Ximian Desktop 2.0 retails for $99 and SuSE 9.0 Professional sells for $79--nice discounts over the retail price of the Microsoft Windows operating system (even with all its patches included).
There's little doubt in my mind that Linux operating systems will continue to gain market share. Hewlett-Packard thinks enough of Novell's Linux systems that it has adopted SuSE Linux as the standard Linux operating system for its desktop systems. In addition, Novell has a relationship with IBM that allows its SuSE Linux enterprise-server software to be shipped inside IBM's entire server line. I believe having HP and IBM as hardware partners will only increase awareness of Novell's Linux capabilities in larger companies. This is also good news for IT managers, as it will give them more cost-effective operating-system options.
In the most recent quarter, ending in April, revenue was $293.6 million, with almost 80% related to service and maintenance. New software licenses were only $60.3 million, slightly greater than 20% of total revenue. The good news is that new license revenue actually increased quarter over quarter by 10%. Before being acquired, Ximian and SuSE combined had annual revenue of less than $50 million. In the last quarter, their combined revenue was about $10 million, and all of it fell into the maintenance and service revenue line. My estimate of their 2004 combined annual revenue still will place them substantially under leading Linux software and services provider Red Hat's annual revenue of $126 million for its fiscal year ending in February. Novell's gross margins on software licenses and maintenance were 90% and 57%, respectively.
My best estimate for revenue for fiscal 2004, ending in October, will be around $1.15 billion to $1.2 billion. At the bottom end of the estimate, revenue growth would be a modest 4%. At $9.35 per share and 384.5 million shares outstanding, equity market capitalization is $3.6 billion. Wall Street earnings estimates, based on First Call, show fiscal 2004 earnings per share of 16 cents, moving up to 26 cents next year. This represents a 36-times forward price-to-earnings multiple--not cheap by most measures. Even if you back out the $636 million in cash on the balance sheet, the valuation, in my opinion, still seems fair at best. But this will be an interesting way to play the growth in Linux, so it's probably worth watching.
William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at [email protected]. This article is provided for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security. Bay Isle has no affiliation with, nor does it receive compensation from, any of the companies mentioned above. Bay Isle's current client portfolios may own publicly traded securities in one or more of these companies at any given time.