Does open source have more value within a larger vendor?

Over on The Open Road, Matt Asay analyzes the price paid for three open-source companies: MySQL (bought by Sun Microsystems earlier this week), JBoss (Red Hat), and Zimbra (Yahoo). He concludes that depending upon the revenue assumptions, whether you use trailing or forward-looking revenue numbers, and whether one looks at bookings rather than revenue, the valuations for all three were somewhere in the 15 to 20 times annual revenue range.

This is a big multiple. By contrast, Oracle is paying a multiple of about 4 times for BEA Systems--and some analysts are saying that's too high.

So is this just another bubble in which companies that are considered in the forefront of the Web or open source or whatever get snatched up for unjustifiable sums?

It is true that all of these companies could be considered category leaders. It's clearly so in the case of MySQL (open-source database) and JBoss (open-source application server), so some premium might reasonably attach to their post position. Yet, one would think clear leadership would already be reflected in their revenue numbers, so that can't be the whole story. Is there any other explanation--especially one that doesn't require irrational exuberance?

I think so. As I wrote in the context of Sun's acquisition of MySQL a few days ago, it's hard for standalone, narrowly focused open-source companies to profit. A financial analyst on the Sun/MySQL call estimated that MySQL had annual revenues of $60 million to $80 million in 2007 and operated at about breakeven. Not bad, but considering that MySQL is widely regarded as one of the true open-source success stories, it's hard to view those financial results as better than modest. At issue is that even with an enterprise version and value-add services--in addition to basic support--MySQL converts a small proportion of users into paying customers. That might be OK, but even when it does monetize users, it's pretty much limited to selling them a subscription for its enterprise version--which is still a great bargain by historical proprietary database standards.

However, plug MySQL or some other open-source company into a larger organization and the opportunities increase enormously. In the case of Sun, each MySQL customer that is willing to pay for the Enterprise database is now also a potential customer for Sun professional services, servers, and other software. The same logic applies to JBoss and Zimbra with their respective owners although those paths to incremental monetization may be less clear--and, indeed, Red Hat has publicly admitted that, so far, it hasn't leveraged its JBoss acquisition as well as it might have.

Although there are any number of small and profitable independent software vendors (ISV) in the proprietary software world, small software companies get gobbled up by larger vendors all the time of course. There's often more value in integrated offerings than in point products. Enterprise are also more comfortable sourcing some types of products, such as high-level management tools, from large ISVs or system vendors.

But over and above all the reasons why it's hard to make a profit as a standalone ISV, a look at the market suggests that it's even harder in some ways for standalone open-source ISVs. It's not that their product is any less valuable and it's certainly not less desired. But it's hard to monetize in a standalone way.

That could well be a reason for these high valuations. The value is already there but it takes a larger and more diverse organization to supply the leverage that makes money off that value.