March 25, 2010 / 7:08 PM / 10 years ago

Linux business key to Novell sale

BANGALORE (Reuters) - Investors in software maker Novell Inc NOVL.O may be faced with a difficult choice soon.

On the one hand, the company rejected a recent bid from an investment fund saying it undervalued the company; on the other, the diverse nature of Novell’s businesses may deter strategic buyers from stepping forward with a substantially higher bid.

Holding out for too long, and ending up without any buyer, could be a major risk for Novell and its shareholders.

Earlier this month, Elliott Associates offered to buy the world’s No. 2 maker of the open source Linux operating system for $2 billion, or $5.75 a share.

Shares of the company surged 30 percent a day after the bid, as investors bet on a bigger offer. Last week, Novell decided to put itself on the block.

Novell, which started off in 1979 as a maker of disk operating systems and computers, sells network server operating system that helps connect desktops to office networks. It also offers openSUSE, a version of the Linux operating system, provides identity and security management software, virtualization and IT management services.

Novell’s brand value has diminished in the past decade with its legacy enterprise networking product Netware losing market share to rivals. It is often perceived as a company that lost out to Microsoft in the operating systems war.

“It’s really difficult for any single technology company to benefit from all the pieces they have to offer, which makes it a difficult acquisition,” said Abhey Lamba, analyst at International Strategy & Investment Group.

Investors feel the company might find higher value if it looks at multiple transactions, as a value buyer like Elliott might not assign adequate value to some of its currently languishing but potentially strategic businesses.

Lamba, however, pointed out that multiple transactions could be long drawn and difficult to consummate for a publicly held company.

LINUX IS THE KEY

The key to the whole situation might be Novell’s Linux business, said a person familiar with the company. He believes this business, which has scarcity value, is not valued in Elliott’s offer.

Novell is one of the two companies in the world that provide Linux-based operating systems, which are the main competitors to Microsoft’s (MSFT.O) Windows operating platforms. Rival Red Hat RHT.N dominates the Linux market.

The source said there may be so much interest in the Linux business that strategic buyers would buy the whole company to get it.

Analysts have speculated that companies like HP (HPQ.N), SAP (SAPG.DE), Microsoft and Oracle ORCL.O could all be possible strategic buyers and could be interested in either a part or the entire company.

“We expect double-digit number of strategic buyers will take a look at this,” said Brad Zelnick, analyst at Macquarie Equities Research and ex-employee of Novell.

“But if you look at where the opportunity lies, to us, BMC Software BMC.O makes a lot of sense, as does Microsoft, and even IBM.”

Piper Jaffray analyst Mark Murphy said, “There are various infrastructure technologies at Novell that are potentially attractive at the right price and it is important to consider the recurring high margin maintenance revenue.”

Murphy said CA Inc CA.O looked like a possible acquirer.

“CA has a track record of being willing to entertain this profile of transaction and it is conceivable, although not likely, that Oracle or IBM could have some interest in their Linux business,” Murphy said.

Earlier this month, CA said it would buy privately-held Nimsoft Inc for $350 million in cash - a preoccupation that might take CA away from the equation.

Murphy however said the Nimsoft deal is not a gigantic transaction for CA, and the company may have the bandwidth to take on Novell.

WHAT’S A FAIR DEAL?

Most analysts agreed that $5.75 was too low for Novell, with some pinning the likely price at around $6 to $7 a share.

Eliott’s offer values Novell at about 20 times forward earnings. Before the offer, shares were trading at a multiple of 16.4 times — less than half of what rival Red Hat trades at.

But at the same time, Novell shares have been underperforming for years — they are at the same level they were five years ago. And the mean 12-month price target of analysts is about $5.95, according to Starmine data.

The company has about $1 billion in cash and no debt.

Piper Jaffray’s Murphy believes that Elliott might raise its offer to over $6 a share, but not more than $7.

“Elliott’s offer for the company does not fully reflect the strategic value that Novell presents to an acquirer,” said Macquarie’s Zelnick, whose price target of $7.50 calls for an earnings multiple of about 26.

Additional reporting by Ritsuko Ando in New York; Editing by Saumyadeb Chakrabarty

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