Financial Markets Predict Linux Win Vs. SCO
SCO's stock price provides insight into their chances of winning
Financial markets can be brutal. People who trade based on what they want to happen are preyed upon by people who prefer to analyze what is more likely to happen. Over time, the traders who are correct more often amass more money than those who don't, so their decisions about where to place the money moves markets more. Even if markets are not truly efficient in the sense of reflecting all underlying information, only the naive believe that there are large exploitable inefficiencies.
This makes markets useful for predicting the likelihood of future events, since they provide an incentive for removing personal bias. If you need evidence, look at the Iowa Electronic Markets (IEM), an exchange run by the University of Iowa where you can trade shares in presidential candidates. (Full disclosure: I own a basket of shares in this market). The IEM has consistently outperformed polls at predicting election winners, so the Economist now publishes current prices alongside poll data during key elections.
We can use these same principles to handicap SCO's chances of winning against IBM in their Linux lawsuit.
At first blush, SCO's chances might look reasonable. After all, their stock has risen by over 600% since the lawsuit was filed (from $2.26 On March 5, 2003 to $16.59 last Friday - click here for a current quote). CEO Darl McBride has added approximately $150 million to the company's market valuation, after adjusting for the general increase in stock values (and subtracting their additional cash infusion from BayStar and a bank representing "unnamed private parties").
SCO wants to collect $3 billion from IBM plus another $1 billion in Linux fees from US companies. After subtracting attorney's fees (20% goes directly to the lawyers) and taking out costs for collecting on current Linux installations (perhaps 50%), a win for SCO may bring it about $3 billion. So the market appears to believe that at best, there is 5% chance for SCO to win outright. A 5% shot at $3 billion plus completely changing the open-source landscape is no small feat. While it's a predicted win for IBM/Linux, it's still a big risk for the software market given its potential far-reaching impact.
Options to the rescue (if they were traded)
However, that obscures the fact that corporate lawsuits rarely have such clear outcomes. It's possible investors are expecting SCO to have a 100% of settling for $150 million in cash, for example, which would also bring their valuation up by $150 million. More likely, IBM would just buy the company to put the whole controversy to rest. Either way, the controversy would not spill over into the open source movement or corporate Linux users. The share price could actually reflect a range of outcomes, from very likely low-payoff to unlikely high-payoff scenarios.
Options prices add a new a variable, since they rise with expected volatility. The option would be more valuable with a low chance of a large gain than a high chance of a small gain. If options were trading at almost the full share value, the market would be predicting a small chance of an outright win -- and if they were trading close to nothing, they would be predicting a large chance of certain settlement.
Unfortunately, there are no publicly traded SCO options since it is such a small company (worth less than $100 million before this started). While we cannot derive the financial market's expectations, we can say that investors are predicting at maximum a 5% chance that the outcome will be an outright SCO win. In reality, it's probably much less and the stock price is supported by an expectation of a more likely, less profitable outcome.
Don't worry...yet
Whether you are a corporation using Linux or an advocate of open source software, you should not be worried yet. We are just seeing media hype surrounding a purely financial standoff between IBM and SCO. SCO's share price indicates that they will lose completely or settle in a way that has no effect on the rest of us. If the price of SCO starts rising dramatically, then pay attention: that means their chances are improving.
Categories
Legal Issues , The Economy & Finance1 TrackBacks
Listed below are links to blogs that reference this entry: Financial Markets Predict Linux Win Vs. SCO.
TrackBack URL for this entry: http://ventureblog.com/cgi-bin/mt/mt-tb.cgi/166
VentureBlog has an interesting take on the SCO vs IBM court case based on financial market valuations. They figure investors are anticipating a 5% chance of total SCO success... With discovery cases going against SCO, it looks like the time for putting... Read More
Its extremely dangerous to read a level of omniscience into the markets in general, and stock markets in particular.
Why? Because the markets are merely a collection of Human Beings, who as a group -- and especially when gathered in large groups -- have a tendency towards irrationality and emotional decision making.
For example -- what were the markets telling you in February 2000? I guess they were saying that valuations didn't matter, P/E was irrelelvant, and stock prices had no real correlation to the businessess of their underlying corporations. (Until a month later).
We know how THAT turned out.
What was the market saying in October 2002? That companies were going out of business, the economy was only going to get worse, and that telecom and technology -- down 80% from the peaks -- were worth less than the cash on their balance sheets.
That didn't predict too well either.
As to specific companies, consider the biggest scam in the history of public stock trading -- Enron; Its stock was still wildly inflated many many months after it as revealded to be a fraud. The market, at least at first, didn't want to believe it. Until it had to. But that was 10s of billionso0f dollars later.
Do not imbue God-like omniscience on a collective which turns out to be an only slightly cleverer group of primates . . .