If Linux is free, should shares in Linux companies be free, too? Of course not. But capitalism is struggling mightily to find a foothold in the world of free software. The result has been plummeting stock prices and more than a few red-faced investors.

It's not that Linux isn't being rapidly adopted -- far from it. Linux already accounts for 24 percent of new operating-system shipments and is expected to grow shipments at 28 percent a year, faster than all other operating systems, according to International Data Corporation. It's just that the Linux companies are having a hard time figuring out how to make money from something that's free. Quelle surprise. Last year the entire sector generated a measly $67 million in revenue, which pales in comparison to operating system revenue from Microsoft (Nasdaq: MSFT) alone. The Evil Empire, Linux is not.

Nevertheless, the penguinistas will be flocking to the Linuxworld show in San Jose this week, largely indifferent to whether a few fledgling Linux companies will ever turn a profit.

HOW LOW CAN YOU GO?
Ever since the first giddy days of the Linux revolution, when supporters thought that the open-source movement would end Microsoft's reign as software king, Linux shipments have climbed steadily while the stocks promptly plummeted.

Red Hat (Nasdaq: RHAT) enjoyed some early success after it went public last summer, but since the beginning of this year the stock has fallen 81 percent and is trading at about $20, well off its high of $151. VA Linux Systems (Nasdaq: LNUX) enjoyed the fruits of success instantly, going public in December and soaring more than 700 percent on its first day. Then in March, it used its inflated stock to buy another Linux company that went public in December, Andover.net. But VA Linux has since collapsed. It's down 81 percent for the year.

Meanwhile, by the time Caldera (Nasdaq: CALD) went public in March, Linux hype had started to fade. The stock had a solid (but not spectacular) opening, gaining 110 percent on its first day. But it has nose-dived from its first-day closing price of $29.44 to a record low of $6.13 last week. Stockholders signaled their displeasure early this month when the struggling company decided to buy Santa Cruz Operations's server software and professional services divisions.

Cobalt Networks (Nasdaq: COBT) -- not a Linux pure-play, but associated with the market because of its extensive use of the Linux OS in its appliances -- seems to have found a bottom at $43, off a high of $172. And companies like Corel (Nasdaq: CORL), which tried to ride the momentum behind Linux, have been particularly hard hit. Corel is trading at about $3, more than 90 percent off its high of $44.

In addition, Linuxcare, well funded and supported by the likes of Dell, Motorola, and Sun Microsystems, scrapped its IPO plans in May and was forced to cut jobs. The company has since raised an additional $30 million in a third round of financing, but the likelihood of them refiling for an IPO in this climate is slim at best.

SILVER LINING?
If there is a shred of hope, it lies in the fact that reality has set in and Linux is starting to settle into the markets that make the most sense. "The initial excitement was misguided," says Prakesh Patel, analyst with WR Hambrecht. "People thought Linux would replace Microsoft, but that is not what Linux is for."

What Linux is good at is running smaller embedded devices, like Internet appliances and handhelds. Analysts are expecting the market to be flooded by these devices over the next two years, presenting a strong opportunity for companies to sell their Linux services and prepackaged Linux products to hardware original equipment manufacturers (OEMs).

Though making money off free software continues to be a challenge, Mr. Patel says that most traditional software companies make the bulk of their revenues from support and services. "Giving away software is not revolutionary," he contends.

Analysts say there may be a few short-term trading opportunities around the Linuxworld show, but most of the pure-play Linux companies aren't expected to make money anytime soon. Red Hat and VA Linux do have impressive estimated revenue growth rates for next year of 60 percent and 63 percent respectively. But until Linux companies can demonstrate that they can actually be profitable, the stock outlook is still relatively grim.

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