Research Comment on Red Hat – Smart Money Magazine

Smart Money Magazine, December 12, 2008

Red Hat: Software Maker in the Black

In a rare story of solid earnings results, investors Tuesday pushed up shares of Red Hat (RHT: 13.09*, +0.10, +0.76%) after the software company posted a strong third quarter, beating Wall Street estimates.

In a Monday conference call, CEO Jim Whitehurst said the Linux-focused company had been able to avoid devastating impacts to its business, although foreign currency took out about $2.1 million in net operating results.

"Although movements in foreign exchange rates reduced our reported revenues when measured in local currency or market share or new customers attained, our growth remains strong," he said. "Combined with carefully managed cost we delivered better than expected operating margin, net income, operating cash flow, free cash flow, and earnings per share."

Cantor Fitzgerald analyst David Bayer wrote Tuesday that while customers are cutting back spending, Red Hat managed to renew most of its software licensing deals, even in a more difficult economic environment.

"The company renewed all of its top 25 accounts at 106% of last year’s contract value, consistent with the prior quarter," Jefferies & Co. analyst Katherine Egbert wrote Tuesday. "One large financial services customer significantly downsized their renewal, skewing the overall result."

The size of its deals — and the lower costs of the Linux operating system — puts Red Hat in a relatively good position even as the broader economy contracts, Thomas Weisel Partners analyst Tim Klasell wrote Tuesday.

"We think this trend towards larger deals reflects the snowball effect of Red Hat deployments spreading in the enterprise as companies standardize on Red Hat and use it to replace more and more legacy servers," he wrote.

The Bottom Line: Hold

Information technology is often touted as a group that leads stocks out of recessionary levels, and a less expensive option like Red Hat looks like an attractive name to retain.