Inside the Red Hat IPO

I wrote the code and got in early on the stock -- but was it worth so much trouble?

Topics: Linux,

9:43 p.m. EDT, Wednesday: E-Trade informs me that I am the owner of 400 shares of Red Hat Software, bought at the initial offer price of $14. I exhale breath I’ve been holding for three weeks. Somehow, I never believed it would actually turn out this way, that I’d end up with stock in my hands.

About three weeks ago, on July 20, Red Hat sent an e-mail to hundreds of software developers offering us a chance to participate in its initial public offering, a gesture of support for the community of free-software hackers without whom the company would not exist. But weeks of infighting and confusion — aided and abetted by E-Trade — followed. Now I’ve finally got my stock. Am I happy? Sure. Relieved? Definitely — by the market’s close on Thursday the stock price had reached $72.62. But was it all worth it? The whole process nearly tore our community apart. So, I really don’t know.

How did I get here?

The troubles began two weeks ago, when E-Trade started to turn away hundreds of developers whom Red Hat had invited to participate in its IPO, to buy shares before they passed through other hands and their price swelled. The demographics of the typical Linux hacker ensured that roughly half of the invitees would not pass an eligibility test required by E-Trade. The programmers who had constructed the Linux kernel at the core of Red Hat’s product simply did not fit E-Trade’s profile of an attractive investor.

The free-software-loving masses raged. On sites like Slashdot, hackers began posting invective. They began with an electronic “Boycott E-Trade!!!!!” chant and things escalated from there. Many developers felt they had been misled into sending E-Trade $1,000 checks to open accounts, and then cheated when E-Trade would not refund their money immediately after declaring them ineligible to participate in the IPO.

Stung by the harsh words following its attempted generosity, Red Hat was hamstrung by the “quiet period” restrictions that follow any company’s registration for an IPO, and it could not speak. But predictably, someone posted on the Net a complete set of “correct” answers to the E-Trade eligibility test. E-Trade even offered all the rejected developers a chance to retake the test. By hook or by crook many hackers either squeezed past the eligibility requirements or decided that their ethics would not permit stooping and retired gracefully, if not quietly.



I badly wanted in. I’d been supporting Red Hat since soon after I discovered Linux, and I felt that stockholder-coders like me were vital if Red Hat was going to be able to fight off Wall Street’s bottom-line pressure. And I had written some of the code. My name was in the credits. I held out as long as I could; I wanted to be recognized for my contribution, not for my net worth. But eventually I retook the eligibility test and, with a little financial help from my family, passed.

We crossed our fingers, and the countdown to the Aug. 11 start of trading began. We placed what are called “conditional offers” — if there was a “large expression of interest” in the offering by the general investing public E-Trade reserved the right to sell us fewer shares than we requested, or none at all. The likely price was supposed to be between $10 and $12 a share, but there were no guarantees.

Typically the final share price for an IPO is set the day prior to the start of trading, which gives investors and brokers some time to reassess and prepare. That would have put pricing on Tuesday. Tuesday passed without any word of a fixed price; instead we received warning of a price range change: an increase to $12-$14 per share. E-Trade accompanied this news with a cryptic note: If the IPO priced above $10-$12 a share, E-Trade would require would-be investors to go through all of the offer paperwork again. This baffling requirement came with no explanation at the time. Most investors had explicitly stated an upper limit to their conditional buy offer — 1,000 shares at up to $15 a share, for example — and so had already specified (they thought) their opinions on a price increase.

The next morning, at 10:05, E-Trade announced that Red Hat was pricing at $14, and that it required everyone to resubmit their offers. But less than 40 minutes later, E-Trade announced that the “window had closed” and it was no longer taking resubmissions. Anyone who wasn’t online to receive the warning was just plain screwed.

Predictably, hackers phoned E-Trade and complained. We learned several things. First, we were officially now considered members of an “affinity” program (not developers, or coders, or even the old “open-source community directed shares program members”). Second, E-Trade was not in the habit of telling you anything useful unless you talked to an E-Trade staffer directly. The message declaring that the time window for resubmission had closed was the last public information that the supposedly Internet-savvy E-Trade posted on its Web site. And the “Smart Alert” e-mail sent out by E-Trade to tell investors about the new resubmission requirement was in most cases received by users after the window had already closed.

If you were a loyal, frequent-trading, ordinary member of E-Trade just trying to get in on an IPO, you were out of luck at this point. Unless you caught the 40-minute window, your previous planning was for naught. Caveat emptor.

But if you were an “affinity” member, it was all right. Not that you knew this, of course. E-Trade could take your reconfirmation over the phone … but only if you had already been told that it was taking such reconfirmations over the phone. I had been online when the first resubmission window opened, and I phoned E-Trade immediately. I reconfirmed my conditional offer and reassured the apparently forgetful E-Trade system that I hadn’t changed my mind about $14 being a fine price to purchase the stock. I then posted to Slashdot to tell others the secret. And I took a deep breath.

Red Hat stock began trading an hour later, around 12:30 p.m., at an opening price of $46, a steep gain from the initial $14 price. I sat at my terminal, vainly trying to do real work, as the stock price initially dived. At $40 it leveled out.

At 1:17 p.m., I received another “Smart Alert” from E-Trade: “We were unable to allocate shares. Possible reasons: Offering priced above limit or high demand for shares.”

So I’m a loser. Great.

I called E-Trade to find out exactly why I was being denied shares. I had to tell folks something when they asked — I’d been talking about this all week. The E-Trade rep wasn’t able to tell me. No one knew anything.

I changed my strategy. At 1:32 p.m. I decided to place a buy for 50 shares of Red Hat at the current market price: $46.56. I didn’t care any more about getting in on the bottom floor. I just wanted to hold some Red Hat stock for the long term. Unfortunately, at the $40-plus price, 50 shares was all I could afford. But I got ‘em.

A few minutes later, I surfed over to Slashdot.org to commiserate with the other unlucky E-Traders. Soon a disturbing pattern began to emerge: We couldn’t locate a single person who had been allocated shares. The E-Trade documents stated that shares would be distributed “width-wise”; that is, everyone in the affinity program would get 100 shares before anyone got 200. But not one person had reported receiving even 100 shares. Something smelled fishy.

1:40 p.m.: Tipped off by a Slashdot rumor, I got a hold of a customer rep at E-Trade who said that the first “no shares” message had been an “error.” An automated program had fired the alerts off before E-Trade noticed. Every single affinity program member had been falsely told that he or she wasn’t getting any shares. Some had responded to the message by immediately closing the account. Apparently, they now had no recourse. Some, like me, had spent our account money in other ways. But there was still something I could do about that.

1:45 p.m.: I sold my newly purchased shares of Red Hat at $46.94 in order to have funds to cover my affinity program offer. I almost covered my brokerage fee with the three-eights gain. The stock price continued to rise.

Throughout the afternoon rumors raged. The affinity members were getting their shares. No, they weren’t. Whenever I managed to get two customer service reps in a row who’d tell me the same thing, someone would e-mail me saying they’d been told the opposite. Finally I was told that the affinity shares allocation was “under way.” An hour later, it was still “under way.” Red Hat closed on the market at $52.06. If I’d known that E-Trade was going to dally so much, I could have held onto the stock I purchased and sold it at closing for a 13 percent gain. I didn’t have enough money to care, but I was sure someone would be pissed. All I could do was keep hitting the reload button on the Web page with my E-Trade account information, hoping against hope that something would finally happen.

And, at last, it did. At 9:30 p.m., after slapping reload one more weary time, I found an alert waiting. I had been allocated 400 shares. Hallelujah, praise be.

At 10:43 p.m. E-Trade sent out another “request for reconfirmation of conditional offer.” Does this mean they’ll take away my shares if I don’t jump through more hoops? The e-mail offers three different means to confirm; I do all of them, phone, e-mail and Web. Also, it mentions a 3 p.m. Friday deadline for reconfirmation. I can’t figure out whether this is generosity or incompetence.

As midnight passed, many friends of mine still hadn’t received notification of any kind. But my adventures were completed, at least. I got 400 shares. A nice piece of cash. But at what cost?

Red Hat’s original offer was intended to be a community-solidifying gesture. If you’re cynical, it was intended to strengthen community support in order to improve Red Hat’s bottom line. It did neither. The initial windfall quickly became a huge hassle. The developers who didn’t make each successive hurdle erected by E-Trade became more and more embittered. And, as many members of the community focused on the strategies that would enable them to participate in the offer, the complaints of people who hadn’t been invited to participate grew ever more shrill. Instead of a big love-fest, with hackers celebrating a few more days of not having to worry about who would be buying the Chinese food, the scene turned ugly, with the hackers locked in constant negotiation with E-Trade drones who seemed intent on making the gift as hard as possible to attain. And those, like me, who had to pull on our relatives’ net worth to be included at all had a bitter taste in our mouths.

Red Hat’s offer to the open-source world was intended to be empowering: Ordinary developers would be able to take a financial stake in a company we helped create. Instead, our alienation from the system became more obvious with every passing day. We had no power in this world; no one cared to listen to what we had to say. No developer got more than 500 shares from the affinity program; none of us were going to retire early or change our lifestyle.

But money is not why we write code all day, and hang out on in chat rooms with other developers on the weekends. I can’t explain what makes us write code any more than a poet can tell why he or she writes. But perhaps Free Software Foundation founder Richard Stallman is right about the promise of reward being no real motivator. Certainly this IPO did little to further the goals of free software. Perhaps the next free software company to go public will learn from Red Hat’s mistakes.

C. Scott Ananian is a graduate student at the Laboratory for Computer Science at MIT.

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