Vulture Fund Elliott Swoops Towards Novell

The $1.8 billion offer sounds nice, but would it leave Novell alive?

Yesterday afternoon, hedge-fund Elliott Associates, L.P. (along with another Elliott Management fund, Elliott International, L.P.) sent a nice letter to the Novell, Inc. board of directors to buy Novell for (pinky in mouth now) 1.8 billion dollars.

Okay, it was actually $5.75 per share, for all of Novell's common stock, effective turning Novell into a private company. But it's more dramatic at $1.8 billion, so we'll stick with that.

This comes as a bit of a surprise, in terms of the bidder and their greatly hinted intentions, but this isn't the first time Novell has been eyed as a possible acquisition... at least in rumor space.

In early 2006, for example, there was much speculation afoot that Novell would be taken over by Oracle, when the tea leaves seemed to show that Oracle was unhappy with its then-partnership with Red Hat. It turns out the leaves were right--but instead of buying Novell, Oracle launched Oracle Enterprise Linux.

Before that, in the summer 2004, Sun Microsystems then-COO Jonathan Schwartz speculated about picking up Novell just to keep IBM from getting their hands on it.

"IBM is in a real pickle. Red Hat's dominance leaves IBM almost entirely dependent upon SuSe/Novell. Whoever owns Novell controls the OS on which IBM's future depends. Now that's an interesting thought, isn't it?" Schwartz wrote.

Interesting indeed. Of course, history shows that Sun never made any such move, at least publicly. Rather, they kicked off OpenSolaris later that year.

Of course, now we see one past Novell flirter swallowed up by another, so we know how that turned out. Oracle now has its Linux and now Solaris to leverage enterprise business. (And, I was interested to see, OpenSolaris still lives, for now.)

Today's news is different. Those past flirtations with Novell from Oracle and Sun were just that--flirtations. The offer from Elliott is real and potentially very dangerous.

The stock market reaction to the offer was predictable: Novell's stock surged 27 percent right after the news broke, and it should stay strong for a while until the market figures out if this is a Good Thing.

The Linux community hasn't raised a big fuss, though I suspect they're still absorbing the news. I know I am, for my part. In particular, I am wondering what will happen to Novell if they accept this unsolicited bid?

A key passage in Elliott's letter-slash-press release give some clues:

"Novell is a long-established company that we have followed closely for a considerable period of time. Over the past several years, the Company has attempted to diversify away from its legacy division with a series of acquisitions and changes in strategic focus that have largely been unsuccessful. As a result, we believe the Company's stock has meaningfully underperformed all relevant indices and peers."

First, let's make sure that the "underperformed" label stays firmly in our minds. Whether you buy that or not about Novell, that's the perception Elliott has, and it will drive the entire strategic vision Elliott will have to "fix" Novell if they do acquire the company. Typically when a group of investors comes in with that kind of attitude, they either think the target company is being wasteful (in which case, watch out for sharp cost-cutting measures, like layoffs) or is going in the wrong direction.

It seems Elliott (again, publicly) believes the latter. "Over the past several years, the Company has attempted to diversify away from its legacy division with a series of acquisitions and changes in strategic focus that have largely been unsuccessful," is very interesting because it's probably a not-too-subtle hint that Novell's shift towards Linux has detracted from its "legacy" NetWare business. Where, apparently, Elliott believes there is real value.

Which begs the question, is Elliott crazy or faking us out?

While it is true that the NetWare side of the Novell house has been gradually shrinking over the past few years, and the Linux side is no longer in the minus column, I am not convinced that NetWare's decline was due to an intentional decision to let it languish on Novell's part.

NetWare faded because NetWare is no longer a needed technology. With all apologies to the NetWare folks, it was a good run while it lasted, but where once NetWare dominated the server operating system market (up to 70 percent, by some estimates), market penetration was down to about zero. So low, in fact, that Novell is ending general support for NetWare on March 7, encouraging legacy customers to shift to Open Enterprise Server. Linux and Microsoft products have surpassed NetWare in terms of functionality and ease-of-use.

So, while it's an easy bet to say Elliott's trying to revive the NetWare legacy business, that would be akin to reviving someone who's been in a coma for years literally four days before they go off life support. Possible, but very unlikely.

Nor do I think Elliott is much interested in saving Novell's relationship with Microsoft, which is gradually fading per the original agreement. True, the Microsoft/Novell deal made much money for Novell, but the Linux side of the house has been gradually expanding on top of the Microsoft business, so there isn't a huge perceived need to rescue that deal.

There are some conspiracy theorists that the Elliott hedge funds involved in this purchase request are just a front for Microsoft, Canopy, or [insert antagonist here] in a bid to kill SUSE and the rest of Novell's Linux product line dead. While this is certainly possible, given that like most private hedge funds, Elliott's participants are locked up tighter than the script for the series finale of Lost, I am thinking no--Elliott is not going to kill off Novell or its Linux business on behalf of anyone else.

I suspect Elliott may kill Novell based on its own motives.

Why? A few searches on the Internet reveal a pattern for Elliott investments/acquisitions. Founded by Paul Singer, Elliott tends to specialize in distressed companies as investments--or nations. Elliott purchased $31 million in the Congo Republic's debt a few years back and when the Congo didn't--or couldn't--pay, Elliott sued the nation for $100 million in principal, interest, and penalties. In 2008, the suits were settled, after at least $39 million had already been collected.

It's a pattern of behavior for Elliott: in 1996 Elliott plunked down $11 million for discounted Peruvian debt and sued the country for $58 million. Ultimately, they got the $58 million. This is why Elliott is well-known in financial circles as a vulture fund.

This kind of distressed debt investment is something Elliott likes to do, even in the private sector. The hedge fund had enough invested in WorldCom to served on the beleaguered firm's creditors' committee during WorldCom's bankruptcy. They like to come in and pick up bargains from dying or distressed organizations.

Clearly, these Elliott folks are no pushovers. Nor do I think they are crazy or inept enough to think they can redirect Novell towards a NetWare future, so I think yesterday's offer letter is a bit of a feint. Elliott does see some sort of value in Novell--but likely not in its present form.

I believe it's something in Novell's patent portfolio or intellectual property that Elliott wants. Something like the UNIX rights, for instance. Whatever they want, I don't believe Novell will survive the vivisection that could occur if the acquisition goes through.

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