Linux Linkup for Microsoft, Novell

If you can't beat 'em& a cooperation pact between the rivals could engender enough customer goodwill to outweigh the risks

In a surprising development, Microsoft (MSFT) on Nov. 2 entered into a broad partnership with longtime rival Novell (NOVL) and agreed to provide some support to Linux, the open-source operating system that competes with its own Windows operating system. Linux, which is developed by a community of software developers who share their code, has long been viewed as one of the most serious threats to the lucrative Windows franchise.

Under the agreement, Microsoft will offer sales support for SUSE Linux, a version of the operating system sold by Novell. The two companies have also agreed to develop technologies to make it easier for users to run both SUSE Linux and Microsoft's Windows on their computers. "They said it couldn't be done," Steve Ballmer, Microsoft's chief executive, said in a prepared statement. "This is a new model and a true evolution of our relationship that we think customers will immediately find compelling."

Adapting to Customers

Executives at both companies said that they were turning from competition to cooperation because corporate customers have made it clear they want to use a blend of technologies; Linux on some machines and Windows on others. Rather than frustrating customers with software that doesn't work well together, the two companies hope to make their technologies operate smoothly. "Too often technology companies ask their customers to adapt to them," said Ron Hovsepian, chief executive at Novell. "Today, we are adapting to our customers."

In the Nov. 2 announcement, the two companies said that they had signed three agreements, with a technical cooperation pact covering virtualization, Web-services management, and document-format compatibility. Virtualization is a technology that's becoming increasingly popular among corporations. Such software allows one computer to perform like several, so one server can handle multiple tasks at the same time. The Microsoft-Novell agreement would make it easier for Linux to run on top of virtualized Windows, or vice versa.

Another agreement between the two companies covers patent cooperation and calls for both sides to agree not to pursue patent infringement claims against the other's customers. Finally, the two companies inked a business cooperation agreement under which they will combine marketing and sales resources to provide joint offerings for customers' Linux needs.

Risks and Rewards

There's little downside for Novell in getting the cooperation of Microsoft. After the deal was initially reported by The Wall Street Journal Nov. 2, Novell's stock surged 16%, to close at $6.79 on the Nasdaq. Still, analysts at Citigroup questioned how much of a sales boost Novell will get. "Other than Microsoft upfront payments we see little meaningful revenue upside" for Novell, wrote Citigroup's Brent Thill and associates in a Nov. 2 note.

For Microsoft, however, there may be risks in providing support for an operating system that competes with what is arguably its most important franchise. Corporate customers, for example, may be more inclined to try Linux, or use it more broadly, now that Microsoft is providing its own vote of confidence. That could take away revenues from Microsoft, as it's pushing hard to keep up its growth rate.

The benefit from cooperation, though, may be customer goodwill. Microsoft has seen Linux take a growing share of the server market and even begin to encroach on the personal computer market. By acknowledging that the rival operating system will remain part of customers' computer operations and making its own software work smoothly with Linux, Microsoft may make customers more satisfied with its own products.

"It's obvious that big companies are starting to see Linux as perhaps more of an opportunity than a threat," said Scott Kessler, an analyst at Standard&Poor's, which like BusinessWeek is part of The McGraw-Hill Companies (MHP). "You're seeing them seize upon the potential that they see with that particular type of offering."

It's clear how the major tech players felt about the announcement. Microsoft and Novell lined up a who's who from the industry to endorse their pact. Intel (INTC), Advanced Micro Devices (AMD), Hewlett-Packard (HPQ), IBM (IBM), SAP (SAP), and Dell (DELL) all gave votes of confidence to the deal. "We applaud Novell and Microsoft in their efforts to provide greater Windows and Linux interoperability," said Paul Otellini, chief executive of Intel. "Customers want solutions that meet their individual needs, and higher levels of software interoperability give them the ability to more easily make the best choice."

Keeping Up with Oracle?

This isn't the first move that big software names have recently taken in response to Linux. The Raleigh (N.C.)-based Red Hat (RHAT) is the biggest name in support services for Linux, which has also been threatening software giants like Silicon Valley's Oracle (ORCL). Larry Ellison, Oracle's CEO, on Oct. 25 unveiled a new program for Linux, Oracle Unbreakable Linux, which he says provides support for less money than Red Hat charges (see, 10/26/06, "Oracle's Gambit Crushes Red Hat Shares"). The Novell partnership is "clearly a shot by Microsoft at Linux market leader Red Hat," Citigroup's analyst wrote.

After that news, investors dropped Red Hat's stock by more than 26% on Oct. 26. With more competition on the horizon, Red Hat shares sank 1.6% on Nov. 2 to $16.16 per share on the Nasdaq.

Microsoft and Novell denied that the move was in response to Oracle's initiative. Negotiations on the agreement had been going on for many months, they said, and the agreement "reflects a joint assessment by Novell and Microsoft that customers will be best served by ensuring Linux and Windows can interoperate effectively."

Intellectual property law experts have confirmed that Oracle and others can legally replicate Red Hat Enterprise Linux, Goldman Sachs (GS) analyst Geoffrey Koide said in a research note in May. "Open-source is hot, but by definition leaves the door open to competition," Koide pointed out.

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