After Red Hat announced Tuesday that its income was up in the second quarter, but profits were down due to increased operating expenses related to the the JBoss acquisition, investors flushed the stock in after hours trading. Wall Street has continued the beat-down on Red Hat in the last two days — taking nearly 30% off the stock price with several brokerages downgrading the company’s potential.
But investors may have turned bearish a bit too soon. As a public service to Wall Street — obviously still struggling with how to handle companies working with open source — here are five reasons to remain bullish about Red Hat.
JBoss is going to be a strong business for Red Hat. In Q2, the newly-minted division contributed $7.2M in revenue. While that may not turn many heads on Wall Street, Red Hat acquired JBoss in Q2, which is bit of a short runway. When they acquired JBoss, Red Hat said the application server vendor was on track to do $80M in revenue in 2007. Bundled as a Red Hat stack as it is now, JBoss could easily do better than that in the coming year.
Q3 operating expenses will decrease. The 75% increase in operating expenses that consumed one-third of Red Hat’s Q2 profit can be traced back to the JBoss integration: training sales and support and figuring out how to integrate the middleware component into the company’s overall business. It’s important to remember, this is, in a sense, new ground for the company. In the past, Red Hat has focused more on bundling the eponymous operating system with applications from third-parties than on pushing their own software solutions. It’s going to take sometime and effort for Red Hat to spin this new commitment up and the bump in operating expenses shouldn’t have come as a surprise. If anything it should be an indication of just how serious the company is in making the JBoss acquisition successful.
Linux continues to grow. If you exclude JBoss and options expenses, Red Hat’s profit was $25.1M, up 52% over Q1 and 24% in the same quarter the year prior. Red Hat is growing, profitable, and sitting on a pile of cash — the company makes nearly as much from interest and short-term investments as it does from selling the open source operating system. Linux is to the point where it’s pace of growth is independent of Red Hat. The combination of Linux being just about everywhere these days and Novell becoming a strong competitor means that Red Hat has plenty of room to grow but can’t rest on their laurels.
RHEL 5 is coming. Red Hat’s product cycles are roughly 18 months. RHEL 4, the current version, was released way back in February of 2005, so it’s been a long, long time since the company has seen the sales spike that a new release can generate. And, looking ahead, that initial spike is the first data point in plotting the adoption curve of a new release. And while you may be type that “never buys version one of anything,” you shouldn’t dismiss out of hand that rush for a new release. If you do, you may be too young to remember the feeding frenzy that erupted around Windows 95. Though it may have been marketing hype, marketing is what creates consumer demand, and RHEL is going to be dropping smack into one of the biggest competitive marketing blitzes Red hat is likely to face anytime soon (see the next point).
The “V” Words: Vista and Virtualization. Virtualization’s hot right now and it’s one of the things that RHEL 4 lacks as an integrated feature. SLED 10 has it and RHEL 5 Beta just plugged it in. Whether or not you’re buying into the virtualization hype, this feature will help dive a number of OEM sales next year.
Meanwhile, Microsoft’s Vista is scheduled to begin shipping in early 2007. I can envision two possible scenarios: Microsoft has put years of development and delays into Vista. They’ve angered bulk license customers and kept consumers waiting too long. As a result, the global marketing engine for Vista will outdo any previous branding campaign and drive record levels of Microsoft adoption. Or, the backlash to the high price of Vista licensing and required hardware upgrades will be a boon to RHEL 5, released at roughly the same time.
So, it could be a boom for Red Hat in 2007. I think they might be at the right place at just the right time. But I’m sure you’ll tell me if I’m wrong.