VA Linux: A Case Study In Irrational Exuberance

by

Dare Obasanjo

I have been following VA Linux's stock for the last few months, occurences during the past month have motivated me to write an article about it. VA Linux opened to the highest opening price ever of any stock in the history of the stock market. It jumped almost 700 per cent in its first day day of trading and reached highs of over $320 a share during that day before settling at $239. Currently the stock trades at less than $14.50

VA Linux has thus become the poster child for what Alan Greenspan called irrational exuberance, characterized by unreasonable valuations of publicly listed company's with little concern for their long term investment value, which has plagued the stock market (NASDAQ especially) in recent years most notably mid-1999 to mid-2000

Why So High?

The VA Linux IPO occured at the zenith of the stock market's infatuation with IPOs and was blessed by a unique set of circumstances.

The Microsoft trial was near conclusion and it was clear that Microsoft was going to lose and investors were looking for the Microsoft's replacement and settled upon all things Linux.

The judicious use of the stock market ticker LNUX fooled some investors into believing that they were the Linux company which made the OS that had been touted as the David to Microsoft's Goliath.

Various funds who got in on the pre-IPO stock were obliged to run up the stock after it opened as had become customary with hot IPO issues. More discussion on this can be found at Salon.

Why So Low?

VA Linux is an example of a company in a market that has low barrier to entry, investment guides and Economics textbooks all over the world advise against expecting much from companies in these kinds of business sector because they face too much competition to ever become very valuable.

VA Linux simply sells servers with Linux pre-installed (and owns a bunch of money-losing websites). Due to the fact that Linux is free of licensing costs as well as Open Source there was nothing stopping a company with more resources and a more developed distribution channel from entering VA Linux's market once it was proven that the market for Linux servers existed.

Once Dell, Compaq, IBM, etc began selling Linux servers and leveraged their existing sales and service infrastructure it became less clear exactly what made VA Linux so special as to gain such an immense valuation. The current rash of insider selling indicates that most of the corporate and private investors feel the same way.

Also the recent downturn in dotcomm shares has been the most recent source of setbacks as dotcomms were a major customer of VA Linux.

Postscript

VA Linux shows to what degree the New Economy has abused the IPO process. In the past, IPOs were used by medium-sized/large companies that were moderately successful to raise cash to expand into larger, more successful businesses. The IPO market when VA Linux IPOed was grossly transformed from its original purpose, into a means of giving cash to unproven businesses with no long term prospects with the hope that they could buy success. DrKoop.com, CDNow.com, Webvan, The Globe.com, Pets.com and a host of others have shown now that such thinking is erroneous.

Success has to be earned, not bought © 2000 Dare Obasanjo