Halloween X: Follow The Money

3 Mar 2004

Excuse me, did we say in Halloween IX that Microsoft's under-the-table payoff to SCO for attacking Linux was just eleven million dollars? Turns out we were off by nearly an order of magnitude — it was much, much more than that.

The document below was emailed to me by an anonymous whistleblower inside SCO. He tells me the typos and syntax bobbles were in the original. I could not, when I received it, certify its authenticity, but I presumed that IBM's, Red Hat's, Novell's, AutoZone's, and Daimler-Chryler's lawyers could subpoena the original. On March 4th, within 24 hours of publication, SCO confirmed that the memo is legitimate.

Explanatory comments are interspersed in brown serif font (I changed this from green because of complaints from the colorblind). Particularly noteworthy bits of the original are in red.

--- From the mailbox of chris sontag

From: Mike Anderer
Sent: Sunday, October 12, 2003
To: csontag@sco.com
CC: Bob Bench
Subject: Conversation Friday

Chris Sontag, the recipient of this mail, is Vice-President and general manager of the SCOsource, responsible for (as his company page puts it) overseeing the development and licensing of SCO's immense intellectual property holdings..

Chris:

I know you were going totalk to Bob later Friday, but I figured I would
outline the issues.

Bob Bench is is the Chief Financial Officer of the SCO group. He is in the Cc line.

Mike Anderer is a consultant with an outfit called S2 that bills itself as a Strategic Consulting firm, in their M&A group. His name is in SCO's SEC filings.

S2 held warrants on SCO stock in July 2003. They were thus in a position to profit if they had reason to anticipate a spike in this othwerwise unpromising stock (SCO/Caldera had never been profitable).

Tim Rushing has put together a timeline of events involving Anderer and the SCO/Microsoft connection.

1) Baystar is easy as they were just a Microsoft referral and would be 2%

Baystar Capital is a venture-capital firm. In 2003 SCO got about fifty million dollars from them in a deal that was rumored to have Microsoft's hand behind it. This confirms the rumor.

That is particularly interesting in view of the agreement that gives holders of 33.4% of the Baystar Series A stock the right to approve or or veto actions leading to contingency payments to Boies and the other two law firms. One suspects that digging into the identities of Series A shareholders — and their ties to Microsoft — might yield interesting results.

2) Any licensing deal would be at 5%

3) Much of the other work would go from 2% to 3% as I have engaged in
direct, but this would require according to Bob either Darl or you
signing off on the fact that this ane was not a referral.

Mike Anderer is discussing his fee for brokering the deal.

4)  On the patent side for IPX, where foes that fit it.  I am working
with the lawyers to get these moved from provisional to more complete in
the next week.  I think it will spawn at least 3 patents.  Ed and I are
the inventors on these.  What do we fo here

My original commentary observed that IPX is a network stack developed by Novell. The implication was that Mike Anderer thinks SCO might be able to get a patent lock on it, so they were looking for IP leverage against Novell. This is probably wrong; he was more likely referring to this IPX, a company that exists to help set up patent litigation.

Provisional patent applications "die" in one year from filing date, so whatever applications he;s talking about were filed no earlier than Oct 2002 and converted to real applications no earlier than Oct 2003 (because they aren't done as of the date on the memo). Average pendency for software patents is 2-3 years. The patents thus will most likely not be issued until 2006 (if ever). The applications are generally published 18 months after filing, though. (They must be published unless they intend to file them only in the USA.) So, one might expect to see the applications published in Apr/May 2005.

If the patents in question ever go live, they should be findable with this search once they go live. Right now this search reveals three patents with Anderer's name, and that "Ed" is probably Ed Iacobucci.

5) The RedHat, Acrylis examiniation, there is no upside here is this
billable seperatly.  I bought a PC and loaded up RedHat and will take
that over and work through it with the Lawfirm.  What do we do here?

Acrylis is a company that Caldera (which became SCO) partnered with in 2001; they were later acquired by Caldera. On page 53 of SCO's 2002 10-K it says:

On May 3, 2001, the Company acquired the WhatIfLinux technology from Acrylis, Inc. WhatIfLinux technology provides Open Source users and system administrators with Internet-delivered tools and services for faster, more reliable software management. In consideration for the assets acquired from Acrylis, the Company issued 1.25 million shares of common stock with a market price of $1.95 per share, or approximately $2.4 million, paid $1.0 million in cash and incurred approximately $0.1 million in direct expenses. The Company has accounted for the acquisition of the WhatIfLinux technology using the purchase method of accounting. The allocation of the consideration paid for the WhatIfLinux technology consisted of assigning approximately $3.0 million to purchased technology and $0.5 million to goodwill. The acquired technology is being amortized over a three-year life.

In context, the word "examination" seems likely to refer to examination of a patent claim. One of the inventors on this patent, a man formerly employed at Acrylis and SCO, thinks it might be the one in question. It'a core patent of WhatIf, and certainly reads like it could be used to attack Red Hat Network.

The ongoing lawsuit between Red Hat and SCO is documented here.

I realize the last negotiations are not as much fun, but Microsoft will
have brough in $86 million for us including Baystar.  The next deal we
should be able to get from $16-20, but it will be brutial as it is for
go to makerket work and some licences.  I know we can do this , if
everyone stays on board and still wants to do a deal.  I just want to
get this deal and move away from corp dev and out into the marketing
andfield dollars....In this market we can get $3-5 million in
incremental deals and not have to go through the gauntlet which will get
tougher next week with the SR VP's.

This is the smoking gun. We now know that Microsoft raised $86 million for SCO, but according to the SCO conference call this morning (03 Mar 2004) their cash reserves were $68.5 million. If not for Microsoft, SCO would be at least $15 million in debt today.

The "$16 to $20" is probably $16 to $20 million in cash, and since this memo is five months old that deal is almost certainly completed by now. This means it's possible SCO has burned through as much as $30 million in just a year of barratry.

But there is a more interesting (if farfetched) possibility. Just a couple of days after October 12 SCO's stock price rose sharply from $16 to $20. I don't think the context of the memo supports this reading...but was Microsoft so confident of its ability to manipulate SCO's stock price that it offered to do that as a payoff?

Some people think I'm double-counting that second deal, or that it never went through at all. I'll admit the language is ambiguous, but the low-ball interpretation of the numbers is $66M (Anderer's $86M minus his high $20M figure for the value of the second deal). That's still a hell of lot of money, essentially the entirety of SCO's cash position in its 1Q2004 10Q. So the only difference here is that SCO would merely be flat broke without Microsoft, rather than $15M in the hole.

The part that starts I just want is interesting, too. It looks as though Anderer is talking about shopping for a wealthier patron group within Microsoft's corporate hierarchy; SCO has been taking money from Microsoft corp dev (probably corporate development) but the gauntlet of Microsoft's senior vice-presidents is about to make that more difficult. He thinks they can get more money from marketing and field dollars. Later paragraphs suggest that he's talking about talking co-marketing money out of different groups within Microsoft, probably their Corporate Marketing and Field Marketing groups.

We should line up some small acquisitions here to jump start this if we
do it.  We shoudl also do this ASAP.  Microsoft also indicated there was
a lot more money out there and they would clearly rather use Baystar
"like" entities to help us get signifigantly more money if we want to
grow further or do acquisitions

In other words, Microsoft wanted to funnel its anti-Linux payoff through third parties. Maybe in case the antitrust guys at the Department of Justice happen not to be asleep at the switch?

The bit about acquisitions seems more ominous when you remember that Caldera/SCO has a long history of lawsuits over obsolete technologies stripped out of dead companies — starting with DR-DOS from Digital Research and continuing through USL's System V into the present with the IBM lawsuit.

This Microsoft deal is the Ante to the poker game...We should get this
done and go after several $2-3 Million deals from the expense side of
their company.

So their revenue plan for the future is to hit Microsoft up for money, then hit them up for more money.

The will help us a lot and if we execute we could exit and Unix
componients we have build potentially back to Microsoft or MCS.

MCS probably equals Microsoft Consulting Services here.

I think they are on track and may not be able to push much more this
round, but there are other ways to get money from them, their partners,
investment bank referrals, etc..

Do kepp in mind that they have brough us between $82 million and $86
million if this deal is between $4million per quarter where Rich is at,
or it turns into %5 million wjich is the lowest number Chris had
interest in.

Rich, in context, must be whoever at Microsoft Corporate Development was responsible for haggling with Chris (Sontag) over the magnitude of SCO's payoffs. He is probably Rich Emerson, Microsoft's Senior Vice President of Corporate Development and Strategy. The third-person reference to Chris might seem odd considering that the memo is addressed to him, but people sometimes do that in email when it has more than one recipient.

The "Ante to the poker game" is the $16-$20 million deal that was current at the time the memo was written. Somewhere between $66 and $86 million had already been delivered. Together, they're counting on between $66,000,000 and $106,000,000 from Microsoft's corporate development division alone...

This paragraph, closely read, strongly suggests that "$16 to $20" is in fact a cash spread, not a stock price spread, and is denominated in millions. $4M times 4 quarters is $16M, $5M times 4 quarters is $20M.

There will be more, lons, partnerships, etc..but we need to just get
this one done.  It is too high profile, it is also critical, but they
are not the people to pitch.  We should get what we can from them ad
then work the other and larger areas of the company and groups where
they have real budget and need for our help.

...and that $66 to $106 million is before they hit up the rest of Microsoft.

Let me know your thoughts.

-Mike

There you have it. At least a third of SCO's entire market capitalization, and their entire current cash reserves, is payoffs funnelled from Microsoft. Their 10Qs reveal that every other line of cash inflow is statistical noise by comparison. The brave new SCOsource business model is now clear: sue your customers, shill for Microsoft, kite your stock, and pray you stay out of jail.

Five days after this memo was written, SCO's PR chief Blake Stowell responded to widespread speculation that Microsoft was behind the Bystar deal by vehemently denying it.

This continues to be SCO's party line. Their response acknowledges that the memo is authentic but claims that Anderer — the consultant they hired to find, handle, and brief the Board Of Directors about this kind of Transaction (see the Statement of Work in his contract with SCO), was mistaken about the deal. They would have us believe that Anderer wrote this memo to Chris Sontag expecting to collect a commission for bringing in Microsoft on a deal that, according to SCO, didn't involve Microsoft at all.

We think the kindest interpretation we can put on these events is that Blake Stowell isn't lying through his teeth, but was kept out of the loop so he could honestly deny all knowledge of Microsoft's involvement. If so, we wonder what else SCO's director of PR doesn't know...

And, of course, the next question to ask, the one that might pierce all of SCO's and Microsoft's denials, is a very simple one: did Mike Anderer get paid his commission on this "misunderstood" transaction?

There is reason to believe that the Securities and Exchange Commission is on the case.

On 13 March, Mike Anderer gave an interview on NewsForge in which he says "I suspect Microsoft may have 50 or more of these lawsuits in the queue."