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NEWS ANALYSIS

Red Hat's Significance for AOL

January 21, 2002|CHARLES PILLER | TIMES STAFF WRITER

Reports that media giant AOL Time Warner Inc. may acquire Red Hat Inc., a large distributor of the Linux computer operating system software, suggest that AOL may be opening a new front in its competition with Microsoft Corp.

With Red Hat, AOL would gain technical and marketing expertise for an operating system that competes with Microsoft Windows--the software that runs some 90% of the world's personal computers.

But the value of Red Hat in the ongoing competition between the technology titans might be small at best, experts said. Few PC users have adopted Linux, limiting its potential as a lever against Microsoft's monopoly.

Discussions between Red Hat and AOL were first reported Saturday by the Washington Post, which cited unnamed sources. In a phone interview Saturday, Red Hat Chairman Robert Young said he would not comment on the report. AOL executives could not be reached.

AOL and Microsoft compete head-to-head as Internet service providers and content developers--AOL with its packaged online offerings and vast electronic and print media holdings, Microsoft with the MSN Web portal and the MSNBC cable network.

Microsoft also has made large investments in cable companies. The software giant wants to use those to establish Windows as a key standard for set-top boxes used for interactive television--an important area for AOL, as one of the largest cable TV providers.

A serious foray into the Linux world might be viewed as a response to Microsoft's incursions into AOL's key markets and a direct challenge to Microsoft's flagship software product.

AOL has the financial resources and market muscle to use Linux against Microsoft, analysts agreed. "Whether or not they have the will is another question," said Rob Enderle, an analyst with Giga Information Group. He called the supposed competitive advantages of Red Hat for AOL "wishful thinking."

Linux has become a major operating system for server computers that operate networks of PCs. But because of its relative complexity, Linux has gained little traction in the much larger market of typical PC users.

Red Hat has a market value of $1.4billion. It reported a loss of $15million on sales of $21.5million in its third quarter ended Nov. 30. In the same period a year before, the firm lost $21.4million on sales of $22.4million.

Unlike typical software managed by a single company, Linux uses the "open-source" method, relying on thousands of volunteer programmers who collaborate on its development. Various forms of Linux are available free online. Red Hat and other companies make money by selling specialized versions of the product as well as technical support and training for consumers and businesses.

Linux companies say the system gradually is becoming easier to use. If it can be radically simplified, Linux may eventually become a strong contender in entry-level PCs.

"The general trend is that the PC is more and more like an appliance," said Chris Le Tocq, a software analyst with SageCircle in Los Altos, Calif.

He thinks AOL could consider marketing a branded PC that uses Linux and comes fully equipped with standard consumer applications--such as software for office productivity, Web browsing and digital photography. Such a device could be substantially less costly than a Windows PC. The savings would come from using Linux and other free open-source software in place of commercial offerings such as Windows and Microsoft Office.

Such efforts have been tried without much success in the United States. But Le Tocq said consumers in emerging markets where Windows' dominance is not yet a foregone conclusion, such as China and Latin America, might find a cheap alternative appealing. Such AOL-branded machines would logically include a package deal for Internet service.

"You see Microsoft getting itself into the hardware business" with the new Xbox game device, Le Tocq said. "AOL will think it has to get into the hardware business as well," making Red Hat a piece of that larger puzzle.

Another factor in the likelihood of an AOL-Red Hat deal will be the strategic outlook of Red Hat's top managers. Large or frequent sales of stock by insiders sometimes suggest that a company is in flux.

From July 18 through Dec. 31 of last year, Young sold 886,000 shares of Red Hat stock in 179 transactions, receiving total proceeds of about $4.5 million, according to Thomson Financial. He formally proposed sales of about half a million shares, with proceeds estimated at nearly $2 million. During that period, Red Hat's stock rose from $3.63 to $7.10 a share; it closed Friday at $8.41, down 14 cents in Nasdaq trading.

In the same time frame, members of Young's family or their trust funds proposed sales of more than half a million shares, with proceeds estimated at $2million. There may be some overlap in the proposed sales and actual shares sold.

"You like it a lot better when a key player is on the buy side," said Enderle. "When they are selling over a long period of time, that makes you nervous."

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