Is Novell Selling to VMware?

Enterprise software developer, Novell Inc. (NOVL) is in discussions with the virtualization infrastructure software solutions provider VMware Inc. (VMW - Snapshot Report) to sell its Linux Operating systems business, according to the Wall Street Journal.
 
According to the Journal, Novell is in advanced stages of negotiations with VMware to sell its SUSE Linux operating systems, with the only point of consideration being valuation. Novell acquired the Germany based SUSE AG in 2003.
 
Following the acquisition news, Novell shares rose by 32 cents, or 5.8%, to $5.89.
 
According to the Journal, Novell is also in talks with a software company Attachmate Corp. which is supported by private equity firms like Golden Gate Capital and Francisco Partners, to sell the remaining part of the company that comprises NetWare network operating system.
 
Novell remains a potential takeover candidate and has been approached by various other entities this year. In March, Novell rejected a buyout offer from the investment firm Elliott Associates L.P., citing that the proposal of $5.75 per share (49.0% over the company’s enterprise value)  in cash is inadequate and it undervalues the company's franchise and growth prospects.
 
Elliott is an investment firm with over $16.0 billion in assets and holds approximately 8.5% of Novell’s common stock.
 
We believe Novell’s Linux assets deserve premium valuation as it has a strong customer base and remains a major revenue contributor. Novell remains the #2 maker of the open source Linux operating system.
 
Recently, Novell launched WorkloadIQ to benefit from the rapidly growing intelligent workload management (IWM) market. Novell currently has more than 30 new customers for its WorkloadIQ products.
 
Moreover, the company has an impressive clientele, including Xerox Corp. (XRX - Analyst Report), Ericsson, General Electric Co. (GE - Analyst Report), Monsanto Co. (MON - Analyst Report) and Sony Corp. (SNE - Snapshot Report).
 
Novell has partnerships with VMware and another virtualization company Citrix Systems Inc (CTXS), providing interoperability between their products and extend joint technical support to customers.
 
Despite having a diversified portfolio and strong customer base, Novell remained undervalued particularly due to weak top-line growth in recent times. In the recently ended third quarter of 2010, revenues decreased 8.0% year over year to $199.0 million from $216.1 million in the year-ago quarter.
 
This sluggish growth, coupled with a lack of visibility over management’s long-term strategy, makes Novell a potential acquisition candidate for companies such as Oracle Corp. (ORCL - Analyst Report), its direct competitor Red Hat Inc. (RHT - Snapshot Report), EMC Corp. (EMC - Analyst Report) and VMWare Inc. that are focused on growing their business in the rapidly growing cloud computing market.
 
In our opinion, the potential acquisition will boost VMware’s customer base and enhance its cloud computing abilities, thereby driving top-line growth over the long term. Moreover we are of the opinion that VMware will have the advantage of a first mover, if it clinches the Novell deal.
 
VMware continues to face tough competition from Citrix and Microsoft Corp. (MSFT - Analyst Report) in the virtualization market. We believe SUSE Linux acquisition will boost VMware’s competitive abilities going forward.
 
We therefore maintain a Neutral rating on Novell and VMware on a long-term basis (6-12 months). Both Novell and VMware have a Zacks #3 Rank, which implies Hold rating on a short-term basis.
 

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