On the open source panel at the recent 451 client event I was asked by Raven what impact I expected the current financial situation to have on M&A for open source vendors. I responded that I expected to see an increase in M&A activity related to open source in the first half of next year.

My view was in stark contrast to those expressed during the M&A panel later that afternoon when the general view was that there would be a significant slowdown in M&A spending during 2009 for the IT sector as a whole.

I thought it would be worth explaining why my view of open source M&A opportunities was different from those of the M&A panel.

Is open source a special case? Yes and no. There are two reasons I expect to see more M&As involving open source vendors, only one of which is specifically-related to the fact that the vendors are open source.

The (Im)maturity issue
Let’s say there are 120 meaningful commercial open source vendors operating right now (that number is a guess). Only a handful are public, and only a handful are in a position to think about going public in the next couple of years.

The majority of open source vendors are at the next tier down - they are looking for latter-stage funding to drive business and revenue expansion with the hope of getting towards an exit three-to-five years from now. That is just the sort of position you don’t want to be in given the current financial situation.

Of course there are also a lot of vendors in the same position who are not open source. My sense is that there is a disproportionate number of open source vendors at this stage, however, due to the relative maturity of commercial open source.

A lot of open source vendors raised funds in the first half of the year, but a significant number didn’t and even though there is money out there if you have the fundamentals right, some of the open source vendors out there are going to struggle to find new funding.

Of those some will fail (which is a good thing - I’ll come back to that another day I think), and others will get acquired - either by fellow open source vendors or by proprietary rivals.

The open source issue
That brings us on to the open source-related aspect to all this, which is that open source vendors are potentially going to become more attractive targets. If we assume that open source is likely to prosper in the downturn (which is arguable but like Jay I believe open source may have an advantage in hard economic times especially as significant project spending is delayed while open source becomes even more attractive for smaller, skunkworks-style projects) then proprietary vendors are going to look more at open source vendors.

We expect to see more community open source software usage - rather than commercial open source adoption - in the short term, so proprietary vendors won’t be looking to open source to cover revenue losses but to provide the necessary momentum to lift them out of the mire by up-selling either to commercial support or proprietary alternatives once people do start spending again.

Also if IT spending on proprietary software does stagnate they will need to be seen to be doing something to provide either long-or short-term growth (which is why I would expect to see SaaS as another target market).

1+1=?
Put those two issues together and I believe we will see a number of open source vendors who are happy to be acquired and a significant number of proprietary vendors looking to acquire open source. The question is what impact will this have on the multiples involved for open source vendors.

I don’t believe we will see a repeat of the high valuations we’ve seen in recent years with open source vendors - particularly as the sort of vendors that would command such a valuation won’t be looking to be acquired and the proprietary vendors won’t be prepared to pay above the odds. There could be some bargains out there.

Anyway, that’s the thought process that went through my head between Raven asking me the question and me opening my mouth to answer it (although not in as much detail, clearly). I’d be interested to hear what other people think.