Novell buyout is long overdue

March 3, 2010

A Novell buyout is a private equity dream, and it is long overdue. The U.S. software maker’s shares have languished for 20 years, yet it generates healthy profit and has no debt. Moreover, a big chunk of the company’s $1 billion of cash is trapped overseas. Elliott Associates’ $2 billion bid could draw out other suitors that have dawdled.

Novell’s legacy enterprise networking business is a slowly shrinking cash cow. Clients are locked into paying highly profitable maintenance fees. The company should bring in about $300 million of so of revenue from this business this year. Of that perhaps half will flow through as operating profit, according to analysts. Moreover, this business doesn’t require much capital expenditure.

The company’s other lines of business, including security management, collectively appear to break even or run at a modest loss. A buyer could shut or sell these units and still retain enough cash flow to service debt and have a tidy profit left over.

Another attraction for some buyers is Novell’s overseas cash pile. The company can’t repatriate these funds without taking a tax hit. It could use the cash for overseas acquisitions. But since many other U.S. tech firms are in the same position, attractive candidates are difficult to find.

A change of control could, however, change this equation. Elliott, for example, has both U.S. and overseas funds. It may be able to split Novell up into different geographical units and marry them with the appropriate funds. Each fund would then have direct access to the relevant slug of Novell’s cash, with a smaller tax impact overall.

These dynamics haven’t eluded the market. Novell’s stock traded 5 percent above Elliott’s offer price on Wednesday, perhaps reflecting the possibility that other bidders may enter the fray. While Elliott has bought companies before, it would also presumably enjoy selling its 8.5 percent stake in Novell at a chunky premium.

After all, other private equity firms such as Silver Lake [SILAK.UL] as well as software companies such as Oracle have a history of buying technology companies and cutting costs. Elliott’s move may mark the beginning of the end of Novell shareholders’ time wandering the desert.

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