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 Author:  Topic:  Posted:
Jun 28, 2001
Or to put it less succinctly, is VA Linux (LNUX) a Fucked Company?

At this point, I emphasise that although I habitually refer to companies by their stock tickers, the company and the stock are two different entities. Nothing in this story should be construed as a recommendation to buy, sell or hold the stock, even if it looks like one. I only intend to discuss the problems facing VA -- their reaction to these problems is going to be the important thing.

The reason for this update is, obviously, the press release announcing that VA will get out of the hardware business by the end of the year. Read on ....


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First, the obligatory boasting

It appears that you don't need to know much about software to understand the software business. Two quotes from various articles of mine under the pseudonym "streetlawyer" on OSDN member website kuro5hin:

Not only that, but arguably, the company itself is shying away from the ideas by which Raymond thought he would revolutionise the economy. The latest hope for VA's profitability is to get away from hardware, get away from consulting and to sell copies of the intranet version of Sourceforge. -- from "Eric Raymond Wealth Clock is Down"

This gives a burn rate of $31.1mn per quarter. Which gives VA three quarters to reach profitability, or it will have to cut core functions. Larry Augustin thinks they can make it by October 2002. That's five quarters, by my countin'. Something's gotta give. -- from "VA Linux 10Q Analyzed".

I'm not claiming any special insight into anything -- personally, I thought that the move away from hardware was pretty easy to read between the lines of the VA disclosures. But it's always good for the ego to have a prediction success.

Second, running the numbers

Well, we said that something had to give, and something gave. The publication of the full cashflow statement put it on the line (and incidentally showed that our burn rate estimate couldn't have been far off -- cashflow from operations was negative $62m over nine months). The problem at VA was an excess of costs over revenues, not helped at all by a $7m buildup of inventories and the only thing they could hope to do was to shrink, and fast, to husband the existing cash resources. Meanwhile, it didn't take a Hahvud MBA to realise that if you have to choose between shifting boxes in direct competition with Compaq and IBM, or providing services in a small but obscure software niche, you go with the niche unless you have cash to burn.

So, Larry Augustin, the eleven and a half million dollar man (that's how much cash he's realised by selling VA Linux stock since the IPO) cut the boxes, with 35% of the remaining staff to follow. Greater love hath no man ...

According to the statement, this will reduce the cash burn to $8mn/quarter. Does it add up?

It's hard to say. No, make that, it's impossible to say, because we don't have any separate disclosure of costs and revenues in the hardware business. I'll be charitable at this point and say that if the VA management had known they were going to do this a couple of weeks ago, they would probably not have decided that the best divisional split for their revenues was "OSDN" versus "Systems and Services". In the opinion of this analyst, if you can separate out a business line to close it down, you really ought to separate it out in your accounts. But hindsight is a wonderful thing.

So, a certain amount of triangulation is required. To start off our analysis, here's a synopsis of VA's cashflow statement, with a few explanatory notes (for nine months ended April 28 2001, US$m)

Revenues (FROM INCOME STATEMENT)                                      118
Costs (FROM INCOME STATEMENT)                                        (356)

Net loss -                                                           (235)
Add depreciation back in (SEE BELOW)                                   74
Add back in non-cash elements of loss 
(mainly stock compensation)                                           101

Add in cash from collection of a/c receivable                          17
Subtract cash spent on building inventories                            (7)
Subtract cash spent on prepayment of bills
(usage of money set aside in previous periods)                         (7)
Subtract increase in accounts payable
(revenues accounted for but not yet collected)                        (10)
Correct for other non-cash accounting items                             5

OPERATING CASH BURN                                                   (62)

In order to get from the $62m cash burn in the Q3 accounts to the projected ongoing $24m (ie: three quarters @ $8m/quarter), we need to find $38m. We can get $7m of that by undoing the inventory increase (we're assuming that the inventory can be sold at cost, which may be optimistic), but it's clear that the bulk of the work is going to have to be done by reducing the size of the net loss.

In order to reduce the size of the loss, VA is just going to reduce the size of the business; to work out by how much it intends to shrink, we just work backward from the bottom line; see how much of a loss they need to get rid of, then divide by the net margin on that kind of business.

The effect of the April round of layoffs should come through in the next quarter (Q3 was particularly bloody for LNUX, as the revenues had fallen but the costs hadn't had time to react). That ought to be worth $10m right off the bat, given that the charge made for severance pay of the San Diego bunch was around $3.4m, and they'd likely have been on three month terms. And other one-off items can probably account for another $5m. So the remaining hole is $15m; this is the loss attributable to hardware-related business. If we assume that the gross margin of 14.0% which VA earned at the time of its first SEC filing in 2000 (before Sourceforge etc were a significant part of the business), that would imply that the revenues of LNUX will shrink by $100m when it gets rid of hardware. So when Augustin says in the statement linked above that "VA expects its revenue to significantly decline with the elimination of the hardware segment", he ain't kidding -- we could be seeing an 80% decrease in the turnover of this company. Admittedly the numbers above are heavily dependent on assumptions (particularly, the margin assumption is worryingly arbitrary), but it could be that those fine upstanding citizens, the American Small Business Association, just welcomed another member to their ranks.

Thirdly, assessing the future

I've got a few ideas on a number of subjects which the press release touched upon. Breifly:

  • I don't agree with Steve Gilliard that OSDN is a cash cow for VA. I tend to be of the opinion that while Slashdot was, verifiably, cash generative at the time of the float, a lot has changed since then (the advertiser base of Slashdot was no less heavily weighted toward dot coms than the buyers of VA Linux servers, remember, and although it's true that a banner ad doesn't cost as much as a new router, it's also true that bankrupt companies don't advertise). The Register appears to agree on this one.
  • As mentioned in the first article linked above, I can't help seeing the move toward SourceForge Onsite as a move towards selling software, for money. I don't understand how that fits into the Open Source business model -- in fact, I don't think it does.
  • I'd be interested to know what is to become of the Open Source celebrities on the payroll at VA (the "UberGeeks". When do they jump ship (if at all), and what happens to the new software-driven business model when they do?
  • And of course, the spectre of a takeover has to be on the horizon. At $3.6, VA is trading at half its stated book value -- 50% of the capitalisation of the company can be accounted for by cash in the bank. The period immediately after stabilisation of the cash burn rate (once the risk of a "black hole" has been removed) is often the period when troubled companies become attractive to predators.
But this article is already too long, and I'd like to get some opinions before proceeding. So for now, so long, and don't take any wooden nickels out there!


It would be great... (none / 0) (#1)
by Anya on Thu Jun 28th, 2001 at 06:22:02 AM PST
...if Microsoft launched a bid, now that VA is at a weak point and its shareholders are looking for any way to make money. I seem to have read in some places (ok, on k5 and /., hardly reliable sources) that VA is 'enormously important to the open source community' because of sourceforge and the like. As microsoft is in competition with linux in the low end server market, it would be just the thing if they were to take it over, and close down operations (or even better, mould operations for their own purposes).

Then all the ubergeeks like ESR and whatnot would be under contract to Microsoft, something I would enjoy. And maybe slashdot would be forced to run pro-microsoft banner adds. For all the editorial control they are supposed to have, I am sure they know how to suck up to the power of the day.

This is great. Umm, is VA Linux even more vulnerable to a takeover if it isn't saddled with a nasty, losing hardware business but has control over some high traffic, and very strategically important, sites? I hope so.

The reason I wamt MS to take them over is that I have developed an irrational hatred of /. and freshmeat and open source and the whole shooting match, because of their horrible arrogance and blindness. I would love for them to be controlled by a more humble company, like MS.

Stars! Stars! And all eyes else dead coals.

I hope not (none / 0) (#2)
by iat on Thu Jun 28th, 2001 at 06:42:41 AM PST
It would be terrible if Microsoft bought VA Linux. I've always opposed corporate involvement with Linux, and the inevitable demise of VA confirms my worst fears.

If VA is taken over by Microsoft, it is almost certain that Microsoft will put a stop to Linux production. After all, it is not in Microsoft's best interests to support a competitor for Windows. With their poor performance, VA has exposed Linux to a hostile takeover from Microsoft, and has thus signed Linus' death warrant.

If Microsoft buy Linux and close it down, we will all be forced into using Microsoft's OSes. This lack of competition flies in the face of the capitalist free market, and should be rigourously opposed by all right-minded citizens. - love it or leave it.

IBM would be a better fit than Microsoft. (none / 0) (#4)
by dmg on Thu Jun 28th, 2001 at 07:49:28 AM PST
IBM still remembers when it dominated the computing and IT industry thoughout the 60s and 70s. For some reason it then ditched OS/2 (which was arguably superior to Windows95) and started to dance to Microsoft's tune.

IBM now regrets its dealings with the Redmond retards and is aggressively pursuing a policy of GNU/Linux GNU/Linux and more GNU/Linux from the big iron S390 right down to the smallest of PDSs, even the wristwatch, IBM is becoming synonymous with GNU/Linux.

All this means that IBM could benefit greatly by bying VA. They would gain the important 'kudos' of the open-source community, plus the services of some open-source stars (including ESR) upon whom it is difficult to put a price.

I would imagine that the combined forces of IBMs deep pockets, the kudos of the open source community, and the elite coding skills of the likes of ESR and Alan Cox, IBM could be taking the battle straight to Microsoft.

The only that worries me is the stewardship issue. Can we trust IBM not to corrupt the (sometimes naievely idealistic) purity of the open source belief system ? I mean we have all seen how a few dollar signs can corrupt even the most ardent open-source advocate. Perhaps the 'true believers' will simply have to acknowledge and recognize that (for better or worse) GNU/Linux is now not really any different to W2K from an ideological point of view. Such ideologes will probably transfer their alliegence to Richard M Stallman's Linux competitor: the GNU HURD.

Finally, if VA is to maintain any real credibility with the hardcore of the open source community, they need to rename themselves 'VA GNU/Linux Systems' - after all most of what we now know as Linux is made from GNU tools, originally crafted by Richard M Stallman. You might not like the guy, but for sure he deserves some credit.

time to give a Newtonian demonstration - of a bullet, its mass and its acceleration.
-- MC Hawking

Like me, this outcome was ordained (none / 0) (#5)
by Adam Rightmann on Thu Jun 28th, 2001 at 08:08:14 AM PST
I would question the wisdom on anyone who thought that a capitalistic business model based on a communist practices would succeed. If there is a politic idealogy more inimical to honest businessmen and capitalist practices than communism, I would be astounded. And to base a business on communist practices, well, its like building on sand.

A. Rightmann

The chickens are coming home to roost (3.00 / 1) (#6)
by Anonymous Reader on Thu Jun 28th, 2001 at 08:24:49 AM PST
As a Bible-believing Christian, it warms my heart to see prophecy coming to fruition. No moral person could have possibly believed that VA Linux could take such a hateful business model and make it work. By the glory and grace of God, they have failed. The central concept of Linux usage is exactly the same as the central concept of communism: hatred of Christ. Those who hate Christ will never win; Scripture is clear on this.

What VA Linux has learned is that we have cherished traditions in this country. One of them is a strong, free-market capitalist economy. What Linus Torvalds and his group of leftist European agitators will learn (the hard way) is that we will not condone communism. People need to understand that a lot of brave soldiers died for our way of life, and we need to make one point clear: when you destroy a Windows partition and install Linux on your machine, you may as well be urinating on the collective graves of all the young men who were killed during World War II. People who love Linux hate freedom. People who love Linux hate Christ. People who love Linux will get what's coming to them.

VA Linux is crumbling.

This is a sign of things to come, and is a re-affirmation of Christian faith.

Jesus believed in intellectual property (none / 0) (#7)
by Adam Rightmann on Thu Jun 28th, 2001 at 08:52:28 AM PST
For did He not say, "Give to Ceaser what is Ceaser's?" If Ceaser were to work hard creating a superior operating system, would that not be Caeser's to do with what he wanted?

And if Brutus were to take Caeser's operating system and give it away, would that not be in violation of Scripture?

A. Rightmann

Speaking as a Communist (none / 0) (#8)
by Anya on Thu Jun 28th, 2001 at 08:53:14 AM PST
Speaking as a communist and atheist, I believe that Linux is the future of America. For too long the religious right has dominated the heart and soul of American society, using such proxies as Microsoft, IBM and CNN. Linux represents the flowering of rational, post-renaissence thought in America. The Enlightenment is at last blessing the sunlit uplands of the Midwest, only 250 years later than in Europe.

Linux, with its moral relativism and lack of social hierarchy, where all men work for one another equally, is the new wave of social tolerance and secular humanism. See how the establishment of America quails before it and the European values it is bringing to your dark, primitive, superstitious land.

Comrades! Let us not be put down by the troubles of VA Linux, for it does not matter. The war for the heart and soul of modern America has only just begun, and thanks to our usage of cells perfected in 1960's East Berlin it does not matter what happens to our capitalistic front organisations such as VA Linux, what really matters is what happens in the hearts of the people!

Software is the material wealth of the now, and the ownership of the means of production of software is the ownership of power, and so the ownership of the hearts and souls of the programmers of AMERICA will mean that we own the means of production of America. We are getting there fast, comrades, and soon we shall bestride america with out power and the programming proletariat shall be free and equal, as the Religious Right and the ideas of Jesus Christ of Nazareth rot under the guilt of two thousand years of DEATH.

Go forth and spread the message.

Stars! Stars! And all eyes else dead coals.

You may not believe in God (none / 0) (#9)
by Adam Rightmann on Thu Jun 28th, 2001 at 09:11:58 AM PST
but luckily for you, He believes in you.

I am reminded of an old saw, I believe it was Charles DeGaulle who once said:

If a man at twenty is not a communist, he has no heart.

If a man at fourty is a communist, he has no brain.

Considering that you are a female, ruled by hormones and emotions, with less capacity for logic, I would expect you to change your tune at about 50.

A. Rightmann

De Gaulle (5.00 / 1) (#10)
by Anonymous Reader on Thu Jun 28th, 2001 at 09:18:02 AM PST
Charles De Gaulle might be forgiven for writing "fourty", as he was French. However you are not; I will hunt you down and whip you.

sacre blue! (none / 0) (#12)
by venalcolony on Wed Jul 11th, 2001 at 12:24:24 AM PST
I believe it was Charles DeGaulle who once said:

One musnt put a lot of stock in the opinions of a man who had to endure service to a nation with more varieties of runny cheese than first names.

The difference between trolling and life is life doesnt have to make sense.

Too much (none / 0) (#11)
by ttm on Fri Jun 29th, 2001 at 09:08:29 PM PST
In order to reduce the size of the loss, VA is just going to reduce the size of the business; to work out by how much it intends to shrink, we just work backward from the bottom line; see how much of a loss they need to get rid of, then divide by the net margin on that kind of business.

If VA goes this route, in the end, with all the tax liability they are still stuck with over 7MM in bad debt write off. That's too much to bury. Their invesors will fry them. They will IMO try to push as much inventory as possible at or lightly below cost to show revenue stream wich although wo't dilute the bad debt, it will make for a better story for the investors. I'd say they'll stay the couse for at least 12 to 18 mos.


Take all things in moderation, Including moderation.


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