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.
On the heels of yesterday's Steve Jobs keynote at Macworld, Apple may be the tech company that's top of mind for many readers. However, from an enterprise computing perspective, Sun Microsystem's announcement that it is acquiring MySQL is far more pertinent. News.com's Martin LaMonica summarizes the announcement thusly:
Sun Microsystems will pay $1 billion to buy MySQL, the provider of a popular open-source database.
Sun said Wednesday that it will pay about $800 million in cash for MySQL's stock and take on about $200 million worth of options. MySQL CEO Marten Mickos will join Sun's senior executive team after the transaction closes.
The acquisition is a bold move for Sun, which has embraced open-source software and development practices in an effort to garner more revenue from its software business. Until now, it has sold support services for a competing open-source database, PostgreSQL.
MySQL is one of the most successful open-source companies founded in the past five years. It's part of the popular combination of open-source development products referred to as LAMP, for Linux Apache Web server, MySQL, and the PHP development language, which is broadly used on the Internet and within companies.
Here, I wanted to focus in on one specific implication.
MySQL is the clear category leader in open-source databases; it's the "M" in the LAMP stack that also includes Linux, the Apache Web server, and the Python, Perl, and PHP scripting languages. And LAMP underpins a huge portion of the open-source software world. As a result, MySQL--like JBoss before it was acquired by Red Hat--made a nice little business of selling support subscriptions for its software. Indeed, it was one of the more successful of the more-or-less pure standalone open-source companies.
If that sounds like damning with faint praise, it is a bit. Because so few end users tend to buy support contracts relative to the number of people that use the product, pure open source has been a challenging business model for its practitioners. That's not to say that there aren't companies successfully taking such an approach, but there are no pure open-source Oracles, Microsofts, or VMwares raking in the dough.
Small software companies get bought by larger companies all the time of course. Open source or not, enterprise customers often appreciate the sort of global support that large vendors are better prepared to offer. And the ability to put together sets of products that address broad business problems is more appreciated. However, in the case of open source specifically, the fact that a large vendor can leverage open-source products to sell other software and even hardware creates far more revenue opportunities than when the only thing a company can sell is a support contract on a single piece of software.
In the Sun and MySQL case, for example, one can imagine Sun eyeing the vast population of MySQL users not so much for the opportunity to sell MySQL support contracts but as an entree for selling other Sun middleware, Solaris, and Sun hardware. One can imagine a conversation like this repeated many times: "Oh, you need better performance out of MySQL running on Linux? Of course, we're happy to help. But you might think about Solaris because we have this DTrace tool. We also have this ZFS file system. And, oh, have you heard about Thumper?"
It's not so much that there aren't workable business models around open source. But life is so much easier when those models can include pieces that people have to pay for as well.
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