Wall Street Beat: Novell hits rough waters

Novell may just not be picking the right battles to fight in the software arena, and is getting outflanked by competitors

Open-source software offers one of the more exciting opportunities for users, IT investors and entrepreneurs, but Novell can't seem to capitalize on these trends.

Novell shareholders this week jumped ship after the company announced a disappointing outlook for its third quarter, ending in July. Red Hat, meanwhile, enjoyed a surge in interest in its own stock.

Novell has launched some interesting products and projects. But it may just not be picking the right battles to fight in the software arena, and is getting outflanked by competitors.

Various problems for Novell, whose revenue and share price has been languishing this year, became clear after Wednesday's announcement outlining its second quarter results and its third quarter outlook. For the second quarter, the company reported earnings per share of US$.03, and revenue of $278 million. This was in line with earlier guidance and with what Wall Street analysts expected. But its forecast disappointed: it expects revenue of $239 million to $247 million and EPS of $0.03. Analysts polled by Thomson Financial were expecting earnings of $0.04 and revenue of $283 million.

Market reaction was swift Thursday. Novell (ticker symbol: NOVL) plunged $1.13 to close at $6.60. Red Hat Inc. (RHAT), on the other hand, rose by $2.65 to $28.87. To add salt to the wounds, investment research firm Credit Suisse downgraded its opinion on Novell Thursday, from "outperform" to "neutral."

Novell's critics had been saying the company was spreading itself too thin, and the company did announce last week that it was selling its majority stake in Celerant Consulting for US$77 million to focus on its core Linux and open source software. But this did not cheer investors, who pushed company shares down by $0.11 to $7.75 on the day of the announcement.

The core problem is that while sales of older products have continued to slump, its Linux and open-source products have not gained traction in the market. Sales of traditional NetWare and its Linux successor, Open Enterprise Server (OES), declined by 16 percent in the second quarter compared to the year before. Though Novell is pushing its Suse version of Linux hard, stand-alone Linux sales for the company are only $10 million, or 4 percent of its total sales.

On its part, Red Hat at the end of March announced a 37 percent jump in revenue for its fourth quarter compared to the same quarter last year, generating $78.7 million in Linux sales. Investors so far are buying into Red Hat's strategy to offer tools and move up the software stack. It is offering software-testing tools and plans to sell Java application server vendor JBoss software with its planned acquisition of the company.

Analysts and investors, meanwhile seem to be taking a wait-and-see approach to Novell's plan, announced last month, to challenge Microsoft Corp.'s dominance on the corporate desktop with the Novell Open Workgroup Suite.

There is, finally, a whole ecosystem of interesting startup and niche players in the open source software arena, many of which -- like Pentaho Corp. and Sugar CRM Inc. -- operate innovative business models that call for charging customers only for high-end versions of their products, or offer users pay-as-you-go options.

If Novell's products don't start showing market-share gains soon, doubts about the company's future can only grow.