Novell opens the kimono on Microsoft deal

The 8K form Novell filed with the SEC yesterday, although brief, contains some revealing financial and technical details about the Microsoft deal. One real shocker is the size of the check Novell will be pocketing. Microsoft has committed to slightly over $300 million in net direct payments to Novell over the next five years, consisting of $240 million for distribution rights to SLES (Suse Linux Enterprise Server) and a net of $68 million for the patent covenant. Redmond also promised to throw in another $100 million or so for marketing of SLES by Microsoft's own sales force.

While it's true that Redmond has a lot of loose change lying around (after all, they paid Sun $1.95 billion), this is too much money just to burnish Microsoft's image as a fair-play competitor.

What Microsoft is buying is the right to give users of its future Longhorn Server operating system up to 70,000 copies per year of SLES. Why is it doing this? Because it expects that many of its best enterprise customers are going to be engaging in a massive virtualization of their datacenter servers over the next five years, and it wants to exert some influence over this process. It knows that, despite its best efforts to promote the virtues of OS monoculture, many of these customers will be running a mix of Linux and Windows applications. So Microsoft has concluded that if it can't get kick Linux out entirely from its server OS accounts, it can at least try to persuade customers to virtualize their Linux apps on top of its own Longhorn server boxes rather than on a bunch of additional Linux servers.

Virtualization is just a software layer that tricks several copies of an operating system – or copies of several different operating systems – into running on a single physical server as if each OS had exclusive ownership of the hardware. This way, different applications can share the same piece of hardware without ever being aware of – or being in any way able to interfere with – each other's existence. That's good for both security and availability. Virtualization is a huge win for big datacenters because it lets them consolidate the workloads of multiple server boxes onto a single box, and thereby realize significant savings in capital expenditure. It's so slam-dunk obvious that EMC's VMware - which today has a near monopoly on virtualization for Intel and AMD servers – is bigger than Red Hat and Suse Linux combined and growing twice as fast.

How does all this fit in with Novell and Microsoft? Keep in mind that currently Microsoft doesn't have a true equivalent to VMware's flagship ESX product. But by 2008 Longhorn Server (which will presumably be called Vista Server by then) is scheduled to have its own hypervisor (virtualization layer), currently being developed under the code name Viridian. It just so happens that Viridian is very similar in design to the free and open source Xen hypervisor that has been shipping since July with Novell's SLES 10 (and will ship with Red Hat's forthcoming RHEL5 early next year). So similar in fact that Microsoft has already inked a deal with Silicon Valley startup XenSource to supply software adapters to let Xen-enabled Linux run on Viridian.

So the purpose of last week's deal is simple. It encourages Microsoft customers who are determined to run Linux to pick Suse Linux instead of Red Hat and to virtualize it on Longhorn, starting some time in 2008. This will be good for Longhorn and good for Novell but – oops! – bad for Red Hat. Especially since the deal stipulates (as revealed in the 8K) that Microsoft "will not enter into an agreement with any other Linux distributor to encourage adoption of non-Novell Linux/Windows Server virtualization through a program substantially similar" to this deal. Hmmm, I guess Red Hat, Oracle and Ubuntu don't get to play. I wonder why Ballmer didn't mention this at the press conference?

The amount of money Microsoft is paying Novell to distribute its Linux for this purpose is really quite considerable: $240 million for the five year life of the deal, but paid upfront. This is exactly five times the $48 million annual run rate of Novell's Linux business as of the July quarter. In effect, Microsoft is guaranteeing Novell's current Linux run rate through January 1, 2012.. Novell's own sales efforts and any organic growth from that base will just be icing on the cake. If Novell can't make a go of its Linux business with this kind of help, there's really no hope for them. Realistically, this doesn't mean that Novell will be able to catch Red Hat or even match its much larger rival's growth rate (which might even be boosted by the price cutting imposed by Oracle), but it does mean that Novell, contrary to the rather rude claim of Red Hat's General Counsel the other day, is unlikely to disappear from the Linux market any time soon.