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  Novell may be nearing its final connection

BENJ GALLANDER and BEN STADELMANN

Friday, March 5, 2010

A couple of months ago, we wrote about Hewlett-Packard's takeover of network manufacturer 3Com, which should be completed this spring. 3Com survived the tech wreck, but never really prospered after the bust, so it made sense that it would be gobbled up by a larger, more successful player. This pattern, dubbed "creative destruction" by economist Joseph Schumpeter, is steadily depleting the ranks of enterprises that were tech leaders in the 1990s.

Gateway, a former Contra stock whose cow-spotted boxes were one of that decade's most recognizable brands, is now a subsidiary of Taiwan's Acer. Workstation pioneer Sun Microsystems and inventor of the Java software platform, was sucked up by Oracle. This week, another old stalwart received an unsolicited takeover offer, one that may well mark the beginning of the end for Novell as an independent entity.

In the early days of personal computers, long before wireless hotspots, the machines were not very good at communicating with each other. Novell's product Netware provided that capability to computers using the DOS operating system, and by 1990 the firm had a near monopoly in network software. Later, it tried to cement its leadership position by buying the Unix operating system from AT&T and the popular word processing program WordPerfect. Under the leadership of Eric Schmidt (now CEO of a little company called Google), Novell positioned itself to take advantage of the burgeoning Internet.

We purchased Novell in the dark days near the end of 2002 at a price of $2.90 a share. At that time, it was already evident that Microsoft's strategy of building networking functionality directly into its operating system was seriously undermining revenues from Netware. But we were fairly confident that the corporation's large cash reserves, clean balance sheet and heavy R&D spending would supplement the top line with sales from new products.

Novell did make some progress, especially after its purchase of SUSE Linux, but overall, revenue from its open-source initiative has been insufficient to make up for its dwindling legacy cash cow. It also became mired in complex legal challenges to its ownership of its Unix code, and was ultimately unable to knock Red Hat out of its leadership position.

The bottom line is that Novell's stock price has been treading water rather than doing the front crawl, which led to the unsolicited takeover bid from hedge fund Elliott Associates at $5.75. Perhaps Elliott wants to own the company as is, but the more likely possibility is that they would carve it up and sell the parts. Or perhaps they are trying to flush out other predators to make a higher bid, which would work out well for Elliott, as it already owns 8.5 percent of the company.

With shares trading well over the proposed takeover price, investors clearly think a higher bid will emerge. So do we. This speculation has stirred up a remarkable level of interest. On Wednesday, 141.3 million shares changed hands, about 40 percent of the outstanding float. The normal trading volume is less than five million shares.

Novell is currently examining the offer, and our guess is that they will ask Elliott to sweeten the pot, while perhaps opening the port to other suitors. It's hard to say if somebody like Oracle or IBM will jump into the fray, but the fact that Novell provides an alternative to Mr. Softy makes it a valuable property to acquire.

We're content to hold our shares and see how this plays out. In the end, we anticipate that another mighty oak from tech's old-growth forest will fire up its chainsaw and we'll bank a nice profit.


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