Virtualisation values may be virtual insanity

I'M FEELING confused so maybe INQUIRER readers will be able to help me. In a week where much ink was expended over tumbling international markets and the parlous state of private equity, two funny things happened.

One company, VMware reached a valuation of almost $20 billion within hours of it floating.

Another, Xen Source, agreed a deal to sell out to Citrix for $500 million, despite being a minnow in commercial terms.

Obviously, there's a theme here and the theme is virtualisation. Put simply, the proposition of both these companies is that you can buy fewer servers and max them out with workloads rather than buying lots of servers that sit there underutilised and chewing up valuable real estate and power.

Nothing new in virtualisation, of course, it's been around since, ooh, the 1960s but what's hot about VMware, Xen Source and others is that they're able to virtualise common or garden x86 servers. It's certainly a powerful prospect but is it worth this sort of dough?

Looking at the two firms in question, what makes VMware different from Xen Source is that it has big revenues that are still almost doubling annually. Barring a disaster, VMware will pass $1bn for the first time this fiscal year.

Xen Source, which began life in the University of Cambridge even though it has its headquarters in Palo Alto, California, is comparatively immature. Even by its own account, the first shot at competing with VMware on feature set is only coming now with the release of its v4 product. Despite some impressive recent customer wins, XenSource revenues are still modest, probably in the region of $10m, so Citrix paid the mother of all multiples.

Of course, the bet stock investors are making in VMware, and Citrix is making in Xen Source, is that both will continue to grow very quickly and consistently.

Is it a good punt? A smart gambler will look for not only a good form guide but also the likelihood of obstacles and there is a Grand National's worth of them to come.

For one, so far Microsoft has been friendly towards Xen Source and virtualisation generally, but there is no guarantee that will continue now Citrix is on the scene. The press release Citrix sent out on agreeing the XenSource deal was very interestingly worded with its own section dedicated to what this means for its friends in Redmond.

"The acquisition will also strengthen each company's strong partnership with Microsoft and commitment to the Windows platform. As an independent company, XenSource has built a strategic relationship with Microsoft designed to ensure broad interoperability between XenSource products and the upcoming Microsoft Windows hypervisor, code named ‘Viridian'. This relationship complements and broadens the successful partnership between Citrix and Microsoft in the Windows application delivery, application networking and branch office infrastructure markets."

In a conference call with press, Citrix's Wes Wasson even trumpeted the fact that it had managed to squeeze a quote out of Big Green, noting that this was "unusual".

This is the quote, from Microsoft VP Bob Muglia:

"Although the market is still in the earliest phase, virtualisation already offers significant opportunities for cost savings and innovation. Citrix and XenSource have long been strong partners for Microsoft and it is exciting to see them team up to help move the market forward."

Hmm. Citrix's relationship with Microsoft has certainly been important to both for many years but, speaking to Citrix executives recently, they were very frank that this was not all back-slapping but more of a guarded mutual understanding.

As one of them told me, "With Microsoft, you sleep with one eye open."

Also, as Muglia says, virtualisation is just now taking its baby steps. When Viridian ships, that will be the time to judge Microsoft's relationships with third-party specialists.

There is also a bunch of other virtualisation firms including KVM, Virtual Iron and, most interesting of all, Swsoft, which is under the same management as desktop virtualisation firm Parallels. SWsoft's loquacious chief Serguei Beloussov could be the joker in the pack here but any deal-making between giants and members of this group could change the virtualisation picture again.

Another obstacle comes from the two companies in the limelight themselves. Xen Source founder and CTO Simon Crosby sees the future of virtualisation being built into the stack and wants to sell products at a fraction of VMware's price. Price erosion is highly likely and would be very costly to VMware in particular.

Virtualisation is very real and very hot at present but the current valuations look very high for an immature sector at a time when some firms say IT buying could be softening.

Lots of folks are comparing the VMware IPO with Google's market debut a few years ago but they could also look back a little further to another company that made a massive impression when it floated - and remember that for every Google there is a Netscape. µ