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Citrix Systems has acquired server virtualizaton start-up XenSource for the astonishing sum of $500m - a move reported yesterday by The Register.

The deal gives Citrix an immediate in with the server and desktop slicing set. In addition, it lends XenSource the serious financial muscle needed to compete with market leader VMware. Citrix will use the XenSource technology to expand beyond its application delivery base and into a fresh, growing market.

While the future revenue opportunities appear large, you have to question Citrix's willingness to part with $500m in cash and stock, which includes the assumption of $107m in unvested stock options. Our sources indicate that XenSource had no sales last year and hopes to bring in just $8m this year. Thanks to an agreement with Symantec, XenSource is then looking for up to $20m in revenue next year.

During a conference call to discuss the deal, which must still meet standard closing procedures Citrix VP Wes Wasson defended the purchase price, saying the virtualization market is set to explode. Citrix expects the XenSource unit to result in a "$200m business over the next couple of years."

Rival VMware just enjoyed a spectacular IPO that values the company at close to $20bn.

Citrix looks to attack VMware through a tight relationship with Microsoft. The software maker will develop around the open source Xen hypervisor and build software to run on top of Microsoft's upcoming hypervisor code-named Viridian. XenSource has an existing partnership with Microsoft around server virtualization.

On its own, XenSource could not likely have afforded to build code for both in-house code and Microsoft's wares. With Citrix on its side, such an R&D investment should be no problem.

That means that VMware will need to defend its proprietary hypervisor technology on two fronts. Microsoft and Citrix look set to offer a board set of management software options around their products, while VMware will be pushing a VMware or nothing strategy. Exciting times.

"There is a fundamental, philosophical difference here, if you look at the approach VMware is taking," Wasson said. "They are talking about even building an operating system. They have named Microsoft as a competitor during their IPO roadshow. We have a very different view here."

Citrix has specialized in sending server-side software out to client computers, allowing companies to make broad use of a single software package. More recently, the company began selling a type of virtualized desktop that's sent out from the data center to PCs. XenSource obviously fits into this new strategy. XenSource, meanwhile, grew out of a research project at Cambridge University. The company develops the open source Xen hypervisor and builds management products around that code. It started by going after the Linux x86 server market but has since focused on Windows customers. XenSource enjoyed a ton of attention when it first hit the scene with many billing it was a warm, fuzzy open source rival to VMware. The company, however, has struggled to secure sales.

While Citrix may have paid too much for XenSource,the company deserves credit for making a flashy, potentially lucrative deal. Citrix often lurks in the background and receives little attention despite being a $6bn software maker. It's now a major player in the hottest part of the server market and could well benefit from the expected growth in desktop virtualization.

Citrix's acquisition has it looking like a forward-thinking player that's set to take on a much more prominent role in the data center.

The company has agreed to keep developing the open source Xen platform and expects to provide more details on its support structure for the software in the next couple of months. ®

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