I've been thinking about something for a few days now. It's about the latest Novell-Microsoft deal that was announced on August 20, where Microsoft agreed to buy another $100 million worth of vouchers from Novell. I was wondering: how come two public companies can make a deal that seems to me to be material and yet keep pieces of the deal secret?
We never did get all the details about the original deal from November of 2006 (Novell's 8K). And now there's this new one, which so far is only described in broad strokes. I wonder if we will be kept in the dark about some of its terms too? Isn't there supposed to be a filing within 10 days or so? How is the public to know whether to invest in either company, if we don't know what the deal's terms are with specificity? Are investors supposed to just guess?
Media accounts aren't consistent. For example, some, like Hiawatha Bray in the Boston Globe reported the new deal as a great win for Novell financially:
Microsoft resold $157 million of Novell's Linux licenses as of April, providing a major boost to Novell's revenues. In the second quarter of 2008, ended May 28, revenue for Novell's Linux business was up 31 percent from the previous year.
"Their billings are up quite a bit," said Al Gillen, an operating systems analyst at IDC Corp. in Framingham. "It's been good for Novell."
Others said it was a sign all is not well at Novell, since it has become reliant on an infusion of money from Microsoft, as Sam Varghese phrased it:
The extension of the deal indicates one thing - all the money which has been pumped into Novell so far is not yielding the returns which either company hoped for and it is now time to further subsidise SUSE Linux.
Yes, subsidise SUSE Linux. That is the main game from Microsoft's perspective - the subsidising of a GNU/Linux distribution which Microsoft is slowly infiltrating and trying to control. All this talk about interoperability is so much window (pun intended) dressing.
Which is it? I have no idea. And neither do you. Without reading the agreement, how can we know?
Here's Eric Lai's description of how the deal has been playing out:
Microsoft sold $156 million worth of support vouchers within 18 months to customers such as Wal-Mart, HSBC Holdings, Renault, Southwest Airlines, BMW and others, according to Susan Hauser, general manager of strategic partnerships and licensing at Microsoft.
All told, about 100 companies have bought the subscription vouchers, with a "pretty good percentage" of them being new customers for Novell, said Susan Heystee, vice president and general manager for global strategic alliances at Novell.
Meanwhile, Hauser confirmed that some of the subscription vouchers were sold to customers for less than face value, though none were given away for free.
Though the deal has added to Novell's bottom line and helped make some inroads against market leader Red Hat Inc., Novell's revenue has risen only slightly since the deal was announced nearly two years ago, while its stock price is down slightly.
How much is "a pretty good percentage"? Is it $157 million or $158? And if the vouchers were sold for less than face value, what were they sold for? Do those figures, whichever is the correct figure, reflect the actual amount paid or the value if one ignored the sale? And who got the millions? Both Microsoft and Novell? Do they split the loot? If so, how? Do we never get to know everything? If the vouchers are being distributed in some kind of a fire sale, does Red Hat have a claim perhaps against Microsoft for deliberately destroying its market chances? At a minimum, is that not material information?
Do the new vouchers for services and support cover GPLv3 code? If they do, that's mighty significant, and in fact it could be vital to have that information if there were litigation someday. For that matter, I want to know if I can expect Microsoft to be investigated by the EU Commission or another astute regulatory body, because we've seen how penalties can affect the bottom line, even of Microsoft. Is the deal anticompetitive? For example, what if there were terms in the deal specifically targeting Red Hat, making it hard for the number one Linux distribution to survive? What if the whole point of it, in the end, is to hobble or even destroy Linux as we know it? Investors can be a cold and calculating bunch and they may not care, but they surely want to know what to expect. How can they know, if the agreement's terms are unknown and unknowable?
Datamation's Paul Rubens wonders, in fact, if the purpose of the entire deal, from Microsoft's perspective, is to scope out the enemy and to destroy Red Hat and then eventually stifle Linux itself:
But Microsoft will also get something else of value from the deal: a better idea of what its customers are up to when it comes to Linux. After all, it must dearly like to have a clear understanding of the areas in which its customers are abandoning Windows for Linux, why they are doing so, how much it costs and the difficulties they face. It's a case of heeding the advice of Chinese military strategist Sun-tzu: "Keep your friends close and your enemies closer."...
The deal has a darker side to it as well. Subsidies have a habit of distorting the market, and in this case it's Red Hat and other competitors to SLES that have to struggle against the advantage Microsoft's greenbacks give Novell. If Microsoft tries to use the knowledge it gains from customers to stifle the growth of Linux in the longer term then that's altogether more sinister.
Albeit not exactly surprising.
Obviously Novell must think, like so much Microsoft road kill before it, that it can prevail against Microsoft instead, once it gets a foot in the door to access Microsoft's customers and potential customers. Isn't it sad that the whole world expects Microsoft to play sinister games? But we do. On the other hand, an investor might not care at all about that, but might very much like to read the agreement's terms to quantify the likely benefits to each party to the agreement and to estimate the ultimate victor so as to know who to invest in, if either.
Here's a bizarre story, about the Lincolnshire County Council in the UK migrating from Novell Netware and Groupwise to Microsoft Windows and Exchange, because they purportedly want to save money and need to work faster:
The revamp will see the council migrate 5,500 staff from Novell Netware and Groupwise to Microsoft Windows and Exchange, as well as build a new wide area network and expand its range of thin clients, as it seeks to cut costs and make its IT easier to maintain and manage.
John Ward, programme manager at the council, said in a statement: "We realised that we needed a faster, more reliable IT infrastructure."
So, Novell, how's that partnership working out for you? I read an article like that and I ask myself: why not SUSE Linux? Linux saves money, it's known for its reliability, and it's faster than Windows, in my experience, and I haven't even tried Vista yet, which I hear is slower than XP. How could a customer choose Windows for speed, cost savings, and reliability when Linux is here? Isn't Microsoft explaining the benefits of SUSE? Did they tell the Council about that?
With Microsoft's money and marketing know-how, how is a tagalong partner going to win?
As an investor, I want to consider all possibilities, which means having all material facts available. If I am missing material pieces, it's just guessing. I read conflicting reports about the deal, and I have no way to know which is true. You would need details. For example, we read that Microsoft bought certificates, for which it paid Novell now. So it looks like Novell just made $100 million. But once the vouchers are obtained by customers, then Microsoft gets some of the money the customer pays for the services and support, I'm thinking, or why would they do it? So exactly what is the figure that Novell really gets in the end? I have no idea, and I have no way to find out, unless they file the agreement with the SEC and let me read it.
So, what are the regulations? I had no idea, so I went to look. I hoped to be able to do some research and get a firm understanding, but the truth is, this is a subject that is, for starters, a little squishy in the wording of the regulation and a deep enough subject that lawyers and accountants who specialize in such matters go to conferences to try to keep up with latest developments in this area of speciality, so the odds of me figuring it all out in a couple of days are somewhere between slim to none. So I'll just show you the regulation, and the exception, and let those who understand all this better than I do figure out the answer to my question: why doesn't Novell have to reveal the terms of this agreement in a filing with the SEC? Or Microsoft? I may not know the answer, but I know it's the right question.
Here's the Securities Act of 1933 [PDF]. It's the regulation requiring disclosure of material information. Here's how the SEC describes it:
Securities Act of 1933
Often referred to as the "truth in securities" law, the Securities Act of 1933 has two basic objectives:
require that investors receive financial and other significant information concerning securities being offered for public sale; and
- prohibit deceit, misrepresentations, and other fraud in the sale of securities.
The full text of this Act is available at:
Purpose of Registration
A primary means of accomplishing these goals is the disclosure of important financial information through the registration of securities. This information enables investors, not the government, to make informed judgments about whether to purchase a company's securities. While the SEC requires that the information provided be accurate, it does not guarantee it. Investors who purchase securities and suffer losses have important recovery rights if they can prove that there was incomplete or inaccurate disclosure of important information.
That last sentence would worry me, if I were a public company that was withholding "important financial information".
The list of required information in a registration statement begins on page 15, and on page 17, I see that the SEC can take action if it notices information is missing to rectify the matter, subject to court review. On page 21, there begins the list of required information in a prospectus, and on page 22 it tells who a member of the public can sue, if it feels material information was withheld with resulting damage, if within one year of discovery of the omission of information, and subject to some limitations of remedies and directions given on pages 27 and 28. I note on page 52 that the SEC tells us how to know if a contract is material and thus necessary to put on Schedule A:
(24) dates of and parties to, and the general effect concisely stated of every material contract made, not in the ordinary course of business, which contract is to be executed in whole or in part at or after the filing of the registration statement or which contract has been made not more than two years before such filing. Any management contract or contract providing for special bonuses or profit-sharing arrangements, and every material patent or contract for a material patent right, and every contract by or with a public utility company or an affiliate thereof, providing for the giving or receiving of technical or financial advice or service (if such contract may involve a charge to any party thereto at a rate in excess of $2,500 per year in cash or securities or anything else of value), shall be deemed a material contract;
So, how come these deals are so vague as far as what the public gets to know? I do see on page 49 that the SEC can exempt any entity or transaction it wishes to exempt "to the extent that such exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors", but that seems a bit of a stretch here. On page 53, it says to attach a copy of any such material contract, but it also shows where the wiggle room might be:
(30) a copy of all material contracts referred to in paragraph (24) of this schedule, but no disclosure shall be required of any portion of any such contract if the Commission determines that disclosure of such portion would impair the value of the contract and would not be necessary for the protection of the investors;
How would you interpret that language in the particular fact pattern here? I have no idea. But clearly you can ask for confidential treatment. Probably if you investigated litigation on such topics, you could make a reasonable guess as to how such things are decided normally. Here's the page on SEC enforcement actions, but of course that is only part of the story, since individuals and certain classes can also sue. And here's a book, The Securities Lawyer Handbook, for those who'd like to dig a bit more.