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Uncertain future hits Novell's Q3

Revenues and profits dropping

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What a surprise. A company rejects an unsolicited takeover bid and its board of directors announces that the struggling company is looking at all alternatives, including selling itself or breaking itself up. And then sales unexpectedly go south.

It should have been no surprise to commercial operating system supplier Novell that the uncertainty hanging over its future would be reflected in its finances. But it looks like the financial hit is going to be a bit bigger than Novell expected.

In a statement released yesterday after the markets closed, Novell revised downward its guidance for the third quarter of fiscal 2010 ended July 31, saying that it now expects total revenues to be in the range of $197m to $199m, down from the company's previous guidance of sales hitting between $205m and $210m. Novell also took down its non-GAAP operating margins for fiscal Q3, saying they would now come in at between 13 and 15 cents, instead of the 15 cents previously anticipated.

The fact that Novell waited until the quarter closed and did some preliminary math suggests that a number of deals that might have closed in Q3 had been pushed out and that the company's salespeople were working hard to close those deals to avoid lowering guidance. It is hard to say whether the revenue shortfall is due to some of Novell's bigger customers having caught wind of a potential deal between Novell and some third party regarding its future, but this is also a possibility.

Back in March, Novell received an unsolicited takeover deal with a net value of around $940m from Elliott Associates, a New York hedge fund. Novell snubbed the deal three weeks later, and at the same time told Wall Street it was considering its options, including "a return of capital to stockholders through a stock repurchase or cash dividend, strategic partnerships and alliances, joint ventures, a recapitalization and a sale of the company". At the time, Novell was sitting on $991.3m in cash, which is why Elliott Associates is really interested in Novell.

In May, rumors were going around that Novell had indeed started playing The Dating Game, with some 20 different companies all taking a look at Novell to see what they might make of it. Novell refused to confirm the talks were ongoing, of course. But the effect of those talks can be felt just the same.

At the end of May, when Novell reported its second quarter financial results, Ron Hovsepian, Novell's president and chief executive officer, said that the strategic review and the offers it is considering had an adverse impact on deals, particularly those where customers are making long-term choices for operating system or identity management platforms.

Novell didn't say how much of an effect this strategic review was having on its numbers, but software license fees in Q2 were off 8.5 per cent to $27.7m and maintenance and subscription sales were off 2.8 per cent to $153.8m. Total revenues were $204m, down 5.4 per cent, but Novell was able to boost net income by 27.5 per cent to $19.2m.

In the third quarter of fiscal 2008, Novell's revenues were $245.2m, and fell by 11.9 per cent to $216.1m in the third quarter of fiscal 2009, largely because software license revenues plummeted by 49 per cent in the quarter to $27m. A year ago, the issue was NetWare sales collapsing and the economic meltdown holding down sales of SUSE Linux and identity management and security products, but then again, Linux rival Red Hat grew through the downturn and has accelerated its growth this year as the global economy has stabilized somewhat.

Obviously, Novell's shareholders had been hoping that the company would be able to hit the high point in its former guidance. Now, at the midpoint of the new guidance, Novell looks to contract by 8.4 per cent in the third quarter of fiscal 2010.

If Novell keeps contracting like this during a recovery, a $940m deal will look like a pretty good one. As we go to press, Novell shares are down 2.7 per cent to $5.85 a pop, giving Novell a market capitalization of $2.1bn. Wall Street doesn't think Novell is worth more than about $1.17bn at the moment, if you don't think the company should carry a premium over market cap minus cash in the bank.

Novell will report its financial results for the third quarter after the market closes on August 26. ®

The smart choice: opportunity from uncertainty

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