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Red Hat buys Hell's Kitchen Systems

Don't let the names fool you; acquisition makes start-up shine

Thursday, January 06, 2000

By Rona Kobell, Post-Gazette Staff Writer

The basement offices of Hell's Kitchen Systems Inc. don't look like much.

  The Hell's Kitchen team includes Andrew Plotkin, left, senior developer; Doug DeJulio, head developer; Larry Weidman, president and CEO; and L. Todd Masco, chief technology officer. They were photographed in their basement headquarters in Squirrel Hill. (Martha Rial, Post-Gazette)

The corridor that passes for a lobby is thick with the smell of perms, thanks to its neighbor, Hair Network. Its cinderblock walls are chipping in some places. Its computer room is only slightly larger than a closet.

But the Squirrel Hill start-up's biggest asset is much less conspicuous than all that: It's a software program that reads credit card numbers.

And it looked good to Red Hat Inc., the leading vendor of the increasingly popular Linux computer operating systems.

So impressed was the North Carolina-based company that yesterday it bought privately held Hell's Kitchen for about 400,000 shares of red-hot Red Hat stock. The deal, valued at $90 million, makes Hell's Kitchen founder L. Todd Masco an overnight millionaire.

It also gives the company a much-desired infusion of capital, though it's not yet clear what Hell's Kitchen plans to do with the money, or even if the four-employee concern will remain in Pittsburgh. Masco says he's still "stunned" by the news -- news that, coming a month after FreeMarkets Inc.'s astronomical stock debut, focused the attention of the country's tech gurus on Pittsburgh.

"It points to the strengths of the brainpower of Pittsburgh technology companies," said Tom Canfield, principal of local investment firm, Equity Catalysts.

Linux is an example of what is known as "open source" computer systems. Unlike conventional companies such as Microsoft, Linux-based systems give customers source codes so they can update the software as they see fit. The idea is to constantly improve software and share innovations with other customers.

On the open-source market, companies such as Red Hat bundle different software components, then sell them to their customers. Their customers can then change them -- and copy them -- free of charge.

Red Hat chairman and co-founder Bob Young compares the old software model to a bridge that is covered so nobody can see how it's built. Only the bridge company knows, and only their engineers can fix it.

But, if users have the blueprints, Young says, they can fix it themselves.

"I ask people, 'Would you want to buy a car with the hood welded shut?' They say 'Of course not.' They might not know how to fix the car, but they can take it to any mechanic and get it fixed. In the software business, you don't have that choice."

Young says the new model has forced open-source companies to rethink the way they make money. The answer, he says, is customer service. Make the software affordable, and customers will come back for support services.

Red Hat is the largest of the 40 or so Linux software vendors, accounting for more than half of the market share for Linux products.

Its initial public offering in August was one of the year's biggest IPOs, with its shares soaring from 14 to 300. Just two weeks ago, its board of directors announced a 2-for-1 stock split. It closed yesterday at 256, up 41.

The deal with Hell's Kitchen positions Red Hat as a player in e-commerce software.

Now, it can lure customers who want to set up e-commerce Web sites with its own credit-card-scanning technology.

Dan Kusnetzky, a program director at International Data Corp. in Framingham, Mass., has been following Red Hat's success since 1995. He says the deal gives Red Hat a much-needed e-commerce component and lends the relatively obscure Hell's Kitchen the credibility of Red Hat's name and draw.

"Red Hat is the master of brand recognition," Kusnetzky said. "Their brand is recognized in places it isn't even sold."

Red Hat's announcement shines a spotlight into Hell's Kitchen's basement, where three long-haired techies -- and one market-savvy CEO -- quietly work on their product.

Masco, the company's chief technical officer, founded the company in 1994 while living in Hell's Kitchen, a New York City neighborhood. Those were the early days, before became a household name.

"It was clear then that there was a piece missing for processing credit cards," Masco said.

Other companies, notably CyberCash, had developed services for processing credit cards. But they were services, not software, and they charged the customer to act as a middleman between the customer, the bank and the vendor.

Hell's Kitchen's software eliminates the middleman, Masco says. "We're software. You buy it and do the clearing yourself."

Masco graduated from Carnegie Mellon University in 1991 with a physics degree. In 1997, he hooked up with Douglas DeJulio, 31, whom he met at CMU, and moved to Pittsburgh. Andrew Plotkin, 29, another CMU graduate, joined soon after.

In 1998, Masco recruited Larry Weidman, a 46-year-old with two decades of marketing and computer experience, to become president and CEO. Weidman had worked for a number of local technology companies, including the former Galt Technologies and Carnegie Group.

Red Hat also has a CMU connection -- its co-founder, CMU graduate Mark Ewing, used to wear a red hat as he walked between classes. Ewing and Young named their initial software after the hat, and the name stuck.

Yesterday's news comes just four days before Masco's 30th birthday, but he says it's no Cinderella story. "It's been five years of pretty hard work."

The company has come a long way since it tried to register its company name in Pennsylvania and the state accused it of profanity.

It took the muscle of its lawyers at Thorp, Reed & Armstrong, a Pittsburgh law firm, to convince officials Hell's Kitchen was a real place.

Masco says the infusion of cash hasn't hit him yet, and he's not sure what changes the company will make. But at the moment, Hell's Kitchen isn't making any plans to move out of Pittsburgh -- or its basement.

"The great thing about the Web," says Weidman, "is that no one knows where you are."

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