There's nothing like a great quarter to make investors forget about an allegedly bad quarter. While Red Hat (NYSE:RHT) shares were weak after the fiscal third quarter results, the fourth quarter results showed much of the strength that investors have become accustomed to in this name. Valuation is problematic, but that's hardly unusual with tech stories and it likely won't matter much until the market goes into another "risk-off" phase.
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Strong Results by Most Measures
Companies like IBM (NYSE:IBM) and Oracle (Nasdaq:ORCL) set a fairly positive tone for the software market and Red Hat followed in that wake. Revenue rose 25% year over year. The company's self-reported billings proxy number rose 31% - more than 10% ahead of sell-side expectations and showing considerable acceleration from the third quarter.
Profitability is pretty much the same old story. Operating income rose 23% and the company is still not seeing any particular leverage in sales and marketing - despite a healthy number of $1 million plus and $5 million plus deals. To a certain extent, I feel like letting go of this as an issue. Red Hat produces pretty solid free cash flow (albeit not a great return on investment capital), and it just happens that the company operates a different model - one that doesn't really lead to pronounced marketing leverage.
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Filling in and Moving Forward
I know it's commonplace to focus on Red Hat as just a distributor of free Linux software that makes money on the support and services it provides. It also seems equally common to focus on the threat(s) that Novell and Oracle present to that Linux market.
I think that misses the point. The JBOSS acquisition has made Red Hat a real option in service oriented architecture and this higher valued-added software market. This puts the company into more direct competition with Oracle and IBM, but it also expands the addressable market. At the same time, the company continues to put its cash flow back into the business; it recently bought Gluster and quickly turned out an unstructured data product.
My point, then, is that Red Hat is increasingly becoming a diversified enterprise software vendor and not just a niche player with an unconventional sales model.
The Bottom Line
Investors have plenty of style options in the enterprise IT space. IBM, Oracle and CA (Nasdaq:CA) have value angles to them (or at least GARP), but not necessarily blockbuster growth potential. Names like Red Hat, Salesforce.com (NYSE:CRM) and VMware (NYSE:VMW) have the excellent growth, but hefty multiples to match.
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I doubt that there are many value-oriented investors in Red Hat shares today, so most of the shareholder base probably isn't worried about the fair value numbers that a discounted cash flow analysis produces. This is a growth and momentum story now, and so long as the company produces billings growth in the high 20s and the market stays in a risk-seeking mood, the shares may well keep their momentum.
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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.