The Open Road

Venture capitalists have poured $3.2 billion into open-source companies since 1997, according to a new report from The 451 Group. It's about time we started delivering a return on that investment.

(Credit: The 451 Group)

In some ways, of course, this $3.2 billion investment has already been repaid several times over. The Linux Foundation, for example, estimates that that the Linux kernel is worth $10.8 billion in free research and development, and a compelling argument has been made that open-source vendors have already saved customers $60 billion in license fees they'd normally be paying.

Indeed, if you expand beyond just vendor-initiated open source, you quickly get well beyond a few billion dollars in value.

All of this is great, but VCs aren't known for the prettiness of the bows they place on their Christmas presents. They're investing to make a return for themselves, not enterprise IT or developing economies. With few exceptions--including Red Hat, Suse, XenSource, Zimbra, and JBoss--the open-source ecosystem hasn't been fattening the coffers of VCs.

This must change.

I believe we're on the cusp of that change. Here's why:

Alfresco Sales vs. DJIA

(Credit: Matt Asay/CNET)

For my company's last management meeting, I tracked our sales against the Dow Jones Industrial Average since November 2005, when we first started selling our product. As can be seen above, while Alfresco followed the DJIA for the first two years, in the past year, as the DJIA has zigged, we've zagged.

The recession has been very good for open-source Alfresco.

But it's not just us. I've talked with a range of open-source companies that I advise (including SugarCRM, JasperSoft, Volantis, and Openbravo), as well as many that I don't advise (Sun's MySQL, Pentaho, OpenX), and almost universally, every open-source company reports the same thing: economy down, sales up.

This sounds like a perfect storm brewing for impressive VC exits on open-source companies, once valuations catch up with the sales numbers open-source companies are reporting. I would imagine that by late 2009 or early 2010, we'll start to see the economy recover a bit, boosting valuations for mergers and acquisitions. Once that happens, I believe that we'll see VCs start to reap a bountiful harvest on their open-source investments.

Disclosure: I am an employee of Alfresco, an open-source content management and collaboration company.

Follow me on Twitter @mjasay.

Well, that didn't take long. Monty Widenius, one of the founders of MySQL, resigned from Sun Microsystems last week but has already invested some of his hard-earned MySQL dollars in IT Mill, a Finland-based open-source start-up focused on the development of Rich Internet Applications.

While no mention is made of anything other than a financial investment and advisory role for Monty, it's good to see him sticking close to open source and to business. Monty notes that he sees 10 to 15 Finnish companies worthy of investment. It's safe to assume he'll have some money left over, even despite the strong euro.

Maybe IT doesn't matter, after all. At least, not as much as it should.

A recently released survey of chief financial officers and their views on technology spending found that roughly 57 percent say they are getting an acceptable return on investment (ROI) from their tech spending. Lest you think that the CFOs are too distant from the chief information officer to have a true grasp on ROI, keep in mind that the survey found that 41 percent of organizations have CIOs reporting to CFOs. The Computer Sciences Corporation conducted the annual survey of 629 CFOs in association with the Financial Executives Research Foundation.

Other data from the "Technology Issues for Financial Executives" study was equally interesting:

• Among those surveyed, IT spending has increased over the last three years, and is expected to grow in 2008, as well.
• Greater than 50 percent suggest medium to high ROI on technology investments but only 11 percent reported a "high" ROI.
... Read more

Both Red Hat and Oracle had excellent quarters, but Oracle's was apparently not "excellent" enough for Wall Street's tastes. Its shares and the market went south this week on fears that technology spending is in decline.

In addition, Wall Street apparently didn't notice that Red Hat actually raised its fiscal year 2009 guidance this week.

Consolidation is one way to improve earnings in a down market, but open source may well be a better way as The New York Times opined.

Oracle's total software revenue was up 21 percent, to $4.2 billion. Pretty good. Unfortunately, it was well under the 30 percent growth Wall Street was expecting.

More unfortunately, Oracle's third-quarter application license revenue only increased by 6.6 percent, to $451 million, which was well below the 30 percent growth ($553 million) that Wall Street expected.

As Sarah Friar explains in The Wall Street Journal,

...(C)ompanies typically buy such software when they are embarking on new projects and are likely to dial back such purchases in tough economic times.

But the same affliction isn't showing up in Red Hat's earnings. Red Hat's percentages were roughly the same. Red Hat's quarterly revenue rose by 27 percent over the fourth quarter and annual revenue in fiscal year 2008 was up more than 30 percent. Red Hat's numbers are much smaller compared with Oracle's, of course, but one thing that really stands out is its deferred revenue number, which was up 40 percent.

As I read that number, Red Hat is doing more longer-term deals. Basically, it's sitting on a growing mountain of cash that is just waiting for services to be performed before it can recognize that revenue. It means that Red Hat's future is demonstrably, tangibly bright.

Here are some salient facts from the Red Hat announcement:

Total revenue for the quarter was $141.5 million, an increase of 27 percent from the year-ago quarter and 5 percent from the prior quarter. Subscription revenue for the quarter was $121.9 million, up 27 percent year over year and 5 percent sequentially. For the full year, total revenue was $523 million, an increase of 31 percent over fiscal 2007 revenue, and subscription revenue was $449.8 million, up 32 percent from the prior year.

Oracle is projecting 10 percent to 20 percent sequential quarterly growth. Red Hat, too, needs to find ways to super-charge its growth. But for the moment, I think it's enough for the company to be demonstrating a flight to value in recessionary times. Investors may bemoan the fact that it's harder to mint money with an open-source company, but this may simply be a new reality for the software industry.

We had a few decades of anomalous growth when there was a mismatch between the economics of production and consumption (i.e., write once, manufacture an infinite number of my products for roughly zero cost, but charge customers steep prices as if the economics of digital production didn't exist). Open source and the Web are going to bring things back into alignment.

For now, Oracle is a good bet in the stock market. If any company is going to weather the recessionary storm, I'm betting it will. But for those with a longer-term view on the software industry, it would be wise to bet on open source.

Jason Maynard of Credit Suisse has been one of the most influential analysts in the software industry. Jason called for then-Novell CEO Jack Messman's head...and got it. He has been a sharp critic of Red Hat in recent years, suggesting that Red Hat underutilizes its brand assets. Jason has called out the transforming influences of SaaS and open source while still appreciating the execution of Oracle and Microsoft.

Jason Maynard has been very busy and very influential indeed.

Now he's leaving us, however. As he announced last week in an email, Jason is joining the investment side of Credit Suisse's business:

Jim Zemlin is no fun. In an insightful blog posting, the president of the Linux Foundation does a reality check on SCO'S $100 MILLION CASH INFUSION!!!!) and finds...not much reality.

Actually let me be more clear: not only is there no $100 million dollars in cash in SCO's bank account, but if the proposal is accepted, there will only be a conditional availability of that large number.

... Read more

Oliver Alexy of Technische Universitat Munchen (TUM) Business School has written an interesting paper titled "Putting a Value on Openness: The Effect of Product Source Code Releases on the Market Value of Firms." The research traces the impact of open source on company market valuations from January 1, 1999, to April 30, 2007. The research is hampered somewhat by a lack of private-company data, but it still offers up some useful conclusions.

Alexy tracks open source through the pre-bubble era (mostly hype leading to outsized but highly transitory investor returns) to today, where open source is becoming the de facto way of building software businesses. You can see the rise, then fall, and subsequent rise in the graphic at right.

Along the way, he suggests, investors have grown wiser as to what kind of open-source business models make sense.

Intriguingly, the early bible for would-be open-source capitalists (Martin Fink's The Business and Economics of Linux and Open Source) turns out to have offered up mostly wrong advice, so far as investment returns go. Using open source as a competitive weapon to batter competitors yields paltry returns, according to Alexy: