Friday, December 15, 2006

Open Source Acquisitions - Accretive? Strategic?

Will Open Source industry ventures -- based on an open source project, VC-backed and ultimately purchased by a public company -- ultimately be accretive or strategic acquisitions?

An accretive acquisition is supposed to increase the acquiring company's earnings per share (EPS) or future earnings. Typically, the price paid by the acquiring firm is smaller than the addition to its EPS.

Alternatively, an acquisition is "strategic". These acquisitions do not necessary decrease the acquiring company's future earnings but when an acquisition is positioned as "strategic" it is a message to the Street that the price paid by the acquiring firm will not contribute positively to its EPS.

For example, SleepyCat (purchased by Oracle) was, by contract to JBoss, cash-flow-positive and did not take any VC-funding. As an operating entity inside Oracle, it is more likely to be accretive in addition to being strategic.

As another example, JBoss gives Red Hat is an open source Java EE-based application server. It changes the game for Red Hat: They become more vertically integrated, competing with the likes of IBM, Oracle, BEA, CA and others as opposed to competing 1:1 against Microsoft in the operating systems market. While RHAT has other products, RHEL is the their flagship product. Now RHAT has more to sell. This shows that Matthew is smart and strategic.

Oracle, by contrast, needed SleepyCat as an offering in the not-huge-but-important embedded database market and instant "street cred" in the Open Source world. Also, by not acquiring JBoss, they offloaded Mark Fleury (now on paternity leave) on RHAT and increased industry alignments against RHAT while increasing the perception that Oracle is the place for all enterprise-class solutions. This shows that Larry is smart and strategic.

There is no answer available, yet, if JBoss or SleepyCat was the more strategic acquisition. At this point it's a dead heat.

Most open source projects which become operating companies have limited IP, have marginally loyal communities, require lots of capital to make subscription models work optimally and often have employees (read engineers) who are not prepared for corporate life or making a long-term commitment to work for the acquiring company. Merely contributing, or better yet adding, to an acquiring company's earnings means that the company had to be executing prior to the acquisition and also means that the acquired company is able to be more efficient, effective and productive inside the acquired company. It will be interesting to see in 5+ years how many open source companies are accretive.

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