LinuxWatcher

SourceForge: Undervalued Open-Source Stock

Honestly there are so many things wrong with this analysis it's hard to know where to begin. You are correct in that the company is sitting on a lot of cash and that the enterprise value of the company is very low.

However, while the observation that “it has turned a profit for 9 of the past 10 quarters” is technically correct, it ignores the fact that several of those quarters were profitable by virtue of the fact that the company sold off parts of the business and reported the sales proceeds as income. Specifically, the sales of Animation Factory and SourceForge Enterprise Edition. If you look in detail at the underlying financials you will see that the business is borderline break even. So they are not losing money, but they are not making money either. Track, for example, their cash position over the last 3 years ignoring new capital from any private placement rounds.

It is also true that many people download software from SourceForge.net. However the most popular open source software is not on SourceForge.net. It’s interesting that none of the projects you mention in this article (Linux, Open Office, and Firefox) are hosted on SourceForge.net. SourceForge.net is something of the ghetto of open source, mostly hosting small irrelevant bits of code. SourceForge.net is also commonly used to save hosting costs. A few larger projects really host the project elsewhere but utilize SourceForge’s download bandwidth to save costs.

Turning to your catalysts, why would companies like Sun or Red Hat want SourceForge? Both already have broader reach than SourceForge. Buying SourceForge would not help either “expand its open-source software business” since SourceForge is not in the open source software business. The primary source of revenue (68%) at SourceForge is sales of t-shirts, coffee mugs and other “geek” toys at their e-commerce site ThinkGeek.com. The rest of their revenue comes from advertising. Why would Sun or Red Hat want a retail t-shirt shop? Or a place that does a poor job selling ad banners? SourceForge makes no sense business wise to either.

Next, your idea that SourceForge could improve profitability by signing an exclusive advertising deal with Google is naive and laughable. Google is an extremely poor partner for monetizing ad revenue. They pay very little per ad served on partner sites. If you knew anything about what Google typically pays per ad you would realize that SourceForge advertising revenue would actually drop considerably were they to funnel all of it through Google. The only way to high CPM numbers is direct ad sales (which is why all the top media properties do the bulk of their ad business direct). Remnants go to Google for a couple of dollar CPMs.

Now let’s talk about “simple organic growth”. There has been none here for years. In fact, one could argue that the company has been going the other way for years. That’s why the stock is trading so low; investors have lost faith in the ability of the company to generate any organic growth. They have a history of failing to execute that spans years and is now ingrained in the corporate culture. Nothing indicates that the company can stop its decline and demonstrate any growth.

Your discussion about Microsoft is an interesting but totally irrelevant one. The failure of Vista and corresponding growth at companies like Canonical (Ubuntu Linux) and Apple is totally irrelevant to SourceForge. SourceForge.net has nothing to do with Linux, and the success or failure of Linux has no impact on SourceForge. (Well, I suppose more Linux users might be buying t-shirts at ThinkGeek.)

Bottom line – unless SourceForge makes some dramatic changes in its business the company is going nowhere. At about $1.35 per share it’s probably in the right price range - cash on hand plus a small premium for a handful of decaying web sites. Nothing here indicates that's likely to change in the foreseeable future.