Analysis: Open-Source Promenade

Whether Red Hat's $350 million purchase of JBoss proves a wise decision strategically or financially over the long term, it was one that Red Hat had to pull the trigger on if it hopes to compete in the higher-value business-software market.

The acquisition gives Red Hat, already far and away the leader among Linux distributors, an application-software stack that can be tightly integrated with its version of Linux, better equipping the developer to compete in the rapidly growing Service-Oriented Architecture (SOA) market.

"If you look at what Red Hat's long-term product differentiation would have been, it wasn't much," says Michael Goulde, senior analyst on the Applications Development and Infrastructure team at Forrester Research in Cambridge, Mass. "This [acquisition] pulls them up into the higher-end markets with an integrated stack they know works and that has customers. I don't know if I would have paid that much for it though."

Justifying the purchase from an economic standpoint, Red Hat executives cited a recent study by research firm Gartner that pegged the value of the Application Integration and Middleware (AIM) and Portal market at about $6.5 billion in 2006. Red Hat and JBoss execs believe melding the two companies' portfolios will present developers with the technologies they need to better exploit opportunities in that market.

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With the acquisition, Red Hat picks up a well-known, open-source, Java-based application server capable of hosting business applications on both Linux and Windows. JBoss is also in the process of piecing together a suite of open-source Java middleware that includes a portal, messaging and a transaction server. Red Hat currently offers support for a competing open-source application server called Jonas.

"Strategically, what we saw was an opportunity to create an open-source platform that could span the range of development through testing, certification, production and deployment, as well as provide the basis for the next generation of application development [for SOAs]," says Tim Yeaton, senior vice president of Enterprise Solutions at Red Hat.

The acquisition should not significantly alter either company's distribution strategy. JBoss sells its products mostly direct through its inside sales force, while Red Hat derives 61 percent of its revenue indirectly, through OEMs, systems integrators and other channel players.

But Red Hat execs say they plan to take up those channel plans a notch and sign up selected VARs and distributors over the next year.

"Our objective is to not go out and sign up a massive amount of resellers," says Ed Boyajian, vice president of worldwide OEM and North America channel sales at Red Hat. "Rather, we're targeting just those resellers we think offer the most value to their customer segments and that have clearly defined markets."

In the next year or so, Red Hat hopes to recruit 50 to 100 VARs, Boyajian says. Those partners would focus on delivering solutions to users "in the tier below the global 500." Red Hat will continue to sell direct to its largest customers, many of which still prefer to receive products and services that way.

As for JBoss, the company will continue to sell mostly direct, although it does plan to take advantage of Red Hat's worldwide support and sales teams, as well as some resellers "where it makes sense," says Marc Fleury, CEO of JBoss.

"We [do] mainly direct sales, with some going indirect, but it's a very different mix," Fleury says. "It has mostly to do with pricing models. Middleware sales are different than those of operating systems bundled in the box."

NEXT: How the deal could alter the competitive landcape for Red Hat and its existing partners.

The deal has the potential to alter the competitive landscape for Red Hat and its existing partners, putting the open-source developer head-to-head with its core business partners, including IBM, and spurring Red Hat to take a different strategy with some of its rivals. Chief among those is Novell, which itself has relationships with IBM, Oracle and BEA.

"There will have to be some adaptations. Novell will have to approach IBM to have a more aggressive program around WebSphere Community Edition, for instance, and IBM will want a quid pro quo from Red Hat," says Forrester's Goulde. "But I think having JBoss supported on other IBM platforms will help IBM to continue supporting Red Hat."

Adds Yeaton: "Our partnerships with IBM and Oracle are very broad and touch almost every aspect of our businesses. [This deal] does introduce overlap in some areas, but it doesn't change the strategic nature of our relationships or our ability to work with [partners]."

Executives at both companies believe their business models are a good fit for each other, especially given that JBoss shaped its business after Red Hat's subscription-based approach to services and support delivered through an online network. JBoss execs say Red Hat's philosophy is closely aligned with their vision of simplifying app development and taking down cost barriers to adoption.

"Red Hat and JBoss are fully aligned around the belief that the open-source development model continues to change the economics of enterprise IT in favor of the customer," says Matthew Szulik, chairman and CEO of Red Hat. "And we truly believe in the potential of software innovation, once freed from the fetters of proprietary development."

The acquisition brought to an end months of speculation about whether JBoss would be bought or would seek capitalization for an initial public offering, and, if an acquisition was to take place, who would be the buyer. One potential suitor was Oracle, which has been aggressively hunting for open-source software companies in the past six months.

"We were not proactively shopping the company around," Fleury told investors in briefings last month at Red Hat headquarters in Raleigh, N.C. "We did have some offers, but I think our customers and business partners are relieved JBoss is with Red Hat now."

The terms of the deal call for Red Hat to pay 40 percent in cash and 60 percent in Red Hat stock to acquire JBoss, with an additional $70 million owed and subject to financial performance. Red Hat execs say they expect the deal to close by the end of May 2007 and JBoss to contribute to the company's earnings next year.