Open Source M&A Takes Shape
A few notable deals have helped the market for open source M&A get its feet, although some wonder if the valuations overshoot the opportunity
March 10, 2008
Sun Microsystems’ recent buys of open source companies MySQL and Innotek are further legitimizing open source software following a year when more open source companies exchanged hands than in the past. In particular, Sun Microsystems' $1 billion purchase of MySQL, the largest-ever in the space, is a sizable nod to the amount of power that these software developing communities wield in technology M&A. Their clout has grown to the point that software giants, in a sharp reversal from earlier technology business models, appear more than willing to hand over some of the reins.
Open source companies aim to make money with a freely downloaded product that can be openly shaped and altered by its users. While relinquishing control of a product seems anathema to most business models, the high technical usage and free rein demanded by programmers and high-level software users alike appears to be winning out. And despite the glaring disparity between the sector’s growing valuations and the relatively small amounts of revenue posted by their targets, more and more corporations like Sun are finding it is best not to fight it.
“Open source plays very heavily to developers. Developers don’t buy things, they join things” said Brian Moriarty, vice president of business affairs at Sun Microsystems. “They’re attracted to software they can download and work with and develop. They’re more attracted to that model than they would be if they had to buy something and run it.”
Part of the reason behind the run on open source companies is that new software being developed over the last five years adheres to an open source platform. The sector is a huge fishbowl for corporations looking for the next big thing.
Sun Microsystems’ acquisition of MySQL, in particular, is seen as a major coup by several analysts. For one, it immediately gives Sun Microsystems a credible database software offering, something the company had been lacking. Additionally, its database software appeals to a vast array of companies outside of the Internet. And within the Net, the software is preferred by some high-powered players. For instance, MySQL can list Web 2.0 mainstays Google, MySpace and Facebook as customers, and Sun only sees much more growth ahead, Moriarty said.
“The number of instances of MySQL out there is just phenomenal. That number of instances attracts developers who can write to that platform. They view that as fertile ground,” Moriarty said.
Innotek makes open source virtualization software, which allows different operating systems to run on the same computer. While the Innotek community is much smaller than MySQL’s, Moriarty said the buy plays to their virtualization strategy, partly by capturing the loyalty of developers who get can use Innotek software to target different operating systems from one computer. Just judging from the values of open source deals, the focus on developer loyalty is just as important as revenue.
“Software historically was viewed as a licensing business. And people realize that is not the best way to make money,” said Alexander Leventhal, chief executive of Broadgate Consultants. Before joining the public relations firm, he advised on technology deals in D.F. King & Co.’s M&A group.
“You used to look at the cost per engineer when you invest in and buy a tech company,” Leventhal said. “In this case, the engineers don’t work for you. They’re out there doing it for free for whatever reason. You have to value these companies in a whole other way.”
Open source companies typically make their money by charging for support, maintenance and implementation, as well as through selling hardware that supports the free software — the peripheral services necessary to keep software running smoothly and bug-free.
However, detractors to this model point to Citrix Systems $500 million buy of open source virtualization software company XenSource last August. It’s a relatively high valuation for a company that had yet to post $1 million in sales at the time, according to technology analysis firm 451 Group.
“What we find is that as an IT company we have two types of customers. One pays us, the other doesn’t,” says Moriarty. “The one that doesn’t pay us are software developers.”
But, Moriarty adds that the non-paying customers are the ones who add value by “building an ecosystem that includes consumers, CIOs, companies and people that actually use products.”
Part of the understanding lies in factoring these amorphous communities into a corporate culture, critical when any sort of culture clash can leave a software’s developer community cold.
Sun Microsystems itself has weathered criticisms of its open source policy in the past, with some rankling that Sun had been too controlling, according to analysts. In particular, the two sides butted heads over Sun’s signature Java software, whose code Sun Microsystems had been reluctant to part with. Both sides say the relationship is getting better, however.
“Our objective is not to break [the community,] in essence to keep it as vibrant, intact, robust and transparent as it is today,” Sun’s Moriarty said. “We integrate it by trying to leave it alone in the good sense, feeding it, giving it resources, but also letting the community do its thing without trying to put a lot of corporate overhead on it.”
An even surer sign of the growing power of the developer ranks occurred in February, when software giant Microsoft agreed to cede some control over its software. Microsoft said it would make some of its software’s DNA freely visible through the Net, the goal being to spur the development of software-enhancing applications.
“You can’t fight the man. It’s the nature of institutionalization: New ideas replace stodgy institutions,” Leventhal said.
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