And on goes my fascination with open source companies and their valuations…
I was reading Stephen O’Grady’s commentary on open source companies and their valuations prompted by the recent acquisition of MySQL by Sun for $1 billion. He quotes Jeff Gould who logically questions whether Sun can make the acquisition pay-off.
Stephen also quotes a piece from Knowledge@Wharton on the myth of market share.
It is a common practice of many companies to focus their attention on grabbing market share from their competitors. But such efforts can actually be detrimental to the firm’s profitability, according to Wharton marketing professor J. Scott Armstrong.
Another logical and thoughtful piece by much smarter people than I. 
Part of their support was came from analyzing companies that operating in a pre-Internet market. These companies didn’t benefit from the ability to market and distribute their products over the Internet: GE, Dupont, Union Carbide, and Alcoa. They didn’t have digital products an open source licensing and blocking strategy either. The end result of profitability is still valid but I believe the route to profitability may be different for open source companies.
Open Source Advantage to Profitability: Free Users
On Sun CEO Jonathan Swartz’s blog I saw a video with MySQL CEO Marten Mickos who mentions that MySQL has about 50,000 downloads per day of which 1 in 1000 of them end up paying MySQL money. That’s not that big of surprise. What happens with the other 49,000 users? I suspect a large number of them don’t use MySQL for very long. Let’s say that only half of the 49,000 use it at all. Let’s also say that 10% of that 1800 users do use MySQL instead of a competitor.
That sounds substantial to me. That’s 657,000 users a year, so let’s cut that in half to be on the safe side, 328,500. I suspect those numbers are somewhat correct as I look a the MySQL forums with over 100,000 posts there’s evidence of an active community. You see in my experience I have seen that downloads convert to users and users convert to customers at some consistent rate. In the MySQL number that means that they are adding 18,250 users per year and 328,500 users who are using MySQL instead of some other product. I would suspect that would give any database ISV a run for their money in market share, though that’s still not profitability but it’s starting to be implied.
Giving away free software may sound counter-intuitive but it can give you a huge edge for marketing and distribution. All users free and otherwise can contribute back feedback and be evangelists for your product, if I look at Oracle’s Annual Report to see that they spend for Sales and Marketing.
As of May 31, 2007, we employed 74,674 full-time employees, including 16,902 in sales and marketing, 6,775 in license updates and product support, 25,068 in services, 18,130 in research and development and 7,799 in general and administrative positions.
Though Oracle is not a pure database company and the numbers don’t translate exactly it’s notable that Oracle spends $3.869 billion on sales and marketing with revenue of $5.835 billion or 66% of revenue. While Red Hat spends $145,562,000 million on $335,888,000 or 43% of revenue. I believe there is a huge advantage in the open source model for sales and marketing and I would expect that MySQL has numbers that are as good or better than even Red Hat’s.
What’s the cost to MySQL to distribute the software? Probably a cluster of commodity servers and bandwidth relatively cheap as compared to the Alcoa or Dupont who distribute metal and chemicals.
Financial Doodling
I don’t have the credentials or all the data to make a detailed analysis so I thought I would just pull together the stats I could find and let the reader draw their own conclusions.
My first thought when these numbers came out was, “What did Red Hat do in their first years as a public company?” Since MySQL was set to go public this year they would seem like a likely comparison. Plus since Red Hat trades on the NYSE it has the advantage of a open market setting it’s value rather than a private sale as was the case for MySQL.
In 1998 Red Hat had $10.8 million in revenue with a net operating loss of $130,000 according to their IPO filing. Today they have a market cap of $3.49 Billion and a trailing P/E of 50.42.
For their most recent quarter ending November 30th here are their vitals:
- Revenue–492.65M
- Profit margin–13.97%
- Net Income–75.15M
Let’s use some simple math of market cap as a function of revenue since those are the numbers available to me. Red Hat is trading at about 7 times revenue. So if MySQL where to match that they would have to have $150 million in revenue. I have no idea what the profit margin is for MySQL but if 65% of their revenue comes from licensing revenue I suspect they do pretty well. Also MySQL is seeing tremendous growth without Sun’s worldwide sales force or other resources.
Now let’s also add another data point, Sybase which has a market cap of $2.43 billion and a trailing P/E of 17.08.
For their most recent quarter ending December 31st here are their vitals
- Revenue–1.03B
- Profit Margin–14.51%
- Net Income–$148.85M
And finally there’s Sun’s vitals which include a market cap of $13.61 Billion and a trailing P/E of 24.02.
- Revenue–13.90B
- Profit Margin–4.45%
- Net Income–$618.00
Now here’s the thing that I find notable, each companies quarterly revenue year over year is as follows:
- Red Hat–27.90%
- Sun–.90% (note the decimal point)
- Sybase–15.10%
This is what is really interesting, The other two companies’ are growing at decent rates. Sun’s staying pretty level on their growth. You decide what that means but I think Sun needs new products to push through its channel and MySQL might be the ticket.
Conclusion
One thing is certain. Sun has to make sure MySQL keeps growing and hopefully at the same clip as they have in past years. The only real way to silence their critics is to demonstrate success despite all of us on the outside trying to figure it out how they are going to make their investment pan out.
For more Mark Hinkle, visit his Socialized Software blog.