By Steve Hamm In a legal settlement worthy of a Scott Turow thriller, SCO Group, which claims to hold valuable Unix software-code copyrights, avoided a potentially disastrous turn in its fortunes on June 1 by reaching a settlement with a disgruntled shareholder, BayStar Capital II. SCO (SCOX), a tiny Utah-based outfit, needs all the cash it can get -- and then some -- because it is taking on mighty IBM (IBM) in court over whether Big Blue violated SCO's rights by contributing software code to the open-source Linux operating system.
In the BayStar deal, SCO said it will pay $13 million in cash and issue 2.1 million shares of common stock in exchange for BayStar agreeing to drop its bid to redeem $40 million in preferred shares. Those shares will be retired instead.
The compromise leaves SCO with about $45 million in cash, which means it will probably have enough cash to see its suit against IBM through to the end, according to Dion Cornett of Decatur Jones Equity Partners, the onequity analyst who follows SCO's stock. Even so, he has a sell recommendation on the stock, which on June 1 closed at $4.81, down 7%, before the settlement was announced.
NOW, FOR BIG BLUE. The stock rallied on June 2, closing up 18% to about $5.70. Now that the BayStar dispute is behind it, SCO can focus on IBM. And though most observers consider the litigation a long shot, SCO hopes some day to collect millions of dollars in licensing fees from tech companies and hundreds of corporations that use Linux. "The lottery ticket is more of a winner today than it was yesterday," says Cornett of SCO prospects.
SCO sued IBM more than a year ago, charging the giant violated its rights by contributing software code to Linux. The case is in the discovery phase, and SCO recently asked a judge in Salt Lake City to move the beginning of the jury trial from April, 2005, to September, 2005, because it needs more time to prepare. IBM has denied violating SCO's rights.
The tech industry is watching SCO closely to see if its intellectual-property claims slow the momentum of the fast-growing Linux operating system. So far, industry analysts say few corporations have changed their Linux plans in response to the threat of a SCO lawsuit against them, even though the company has already sued DaimlerChrysler (DCX) and auto parts retailer AutoZone (AZO) for using Linux.
MISSED DATES. SCO continues to push its case. "We won't run out of money before the trial starts," says company spokesman Blake Stowell.
SCO was expected to announce its second-quarter earnings on June 2, but pushed the date back to June 10 after announcing the BayStar settlement. Stowell says the negotiations with BayStar made it impossible to report on schedule. Decatur Jones expects a 46% decline in revenues for the quarter, to $11 million, and a loss of $4.6 million, or 31 cent per share. (The research company and Cornett do not own any shares of SCO stock.)
BayStar had a falling out with SCO in April, when it complained that SCO was wasting money on propping up its Unix business rather than focusing more on the IBM suit. BayStar said June 1 that it's now satisfied with SCO's operating- and cash-management plans. "We're gratified to reach an agreement," says Larry Goldfarb, BayStar's managing general partner.
STYMIED? However, SCO's Stowell says the company has not changed its approach to business in response to BayStar's pressures. "We can do both the litigation and the Unix business," he says. A recent 10% cut in worldwide staffing to 275 puts the company on track to make a profit in its original Unix business, he adds.
Still, while the settlement with BayStar may keep SCO in the game, its litigation shows no outward signs of progress. Both IBM and DaimlerChrysler have asked judges to dismiss the cases against them. "It's increasingly obvious that they're more of a lawsuit than a operating company," says Decatur Jones' Cornett. SCO disagrees, but in the next few months, this stock will be only for those with the biggest appetites for risk. Hamm writes for BusinessWeek in New York