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Red Hat jacks takeover price with 11% revenue leap

Worth more than Sun?

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Commercial Linux distributor Red Hat is doing its best to be one of the few businesses in IT where sales and profits are both growing. And that's making it a more expensive takeover target.

In its first quarter of fiscal 2010, ended on May 31, Red Hat's sales rose by 11.3 per cent to $174.4m, with subscription sales up 13.8 per cent to $148.8m and training and services revenues down 1.3 per cent to $25.6m. Net income wasn't up nearly as much, rising by only 7.1 per cent to $18.5m, but with most of its IT peers seeing revenues flattening or down and net income plummeting, this is a remarkable achievement considering the slowdown in IT spending.

Taking out currency translation effects, revenues would have been up by 17 per cent in the quarter, and earnings per share would have been up by 25 per cent. (This EPS was also helped by Red Hat's buying back 2.7 million shares in the quarter).

In a conference call with Wall Street analysts after the market closed today, Jim Whitehurst, Red Hat's president and chief executive officer, said that of the top 25 deals that came up for renewal in the quarter, all 25 renewed and that the combined value of their contracts exceeded their original value by 20 percent.

Red Hat never talks about such comparisons for its customer base at large, but Charlie Peters, the company's chief financial officer, said that in smaller accounts where Red Hat has been the one selling into that account, the renewal rates are "quite high," while the renewal rates among channel partners are not as high. To that end, Red Hat and its OEM partners are trying to figure out why this is the case, and they're trying to boost the renewal rates, since this is basically money on the table.

In fiscal Q1, 61 per cent of the company's bookings came from the channel and 39 per cent came through Red Hat's own direct sales, which is a pretty big (and intentional) shift from the 56 per cent that went through the channel in the fourth quarter of fiscal 2009. By geographic region, the Americas accounted for 53 per cent of sales, EMEA accounted for 25 per cent, and Asia/Pacific accounted for 22 per cent.

Peters said that the growth of the JBoss middleware business, which had been growing twice as fast as the core Linux business, did not do that in the first fiscal quarter. But of the 30 top deals done in the quarter, 30 per cent of the deals had a middleware component and two of the five big $1 million deals the company did in the top 30 were for middleware products only. Red Hat had one deal that was worth in excess of $5m in the quarter. The company has been trying to get companies that have deployed its open source Fedora or Enterprise Linux distributions to buy subscriptions to support contracts for the official RHEL distribution.

Last quarter, it inked a biggie free-to-pay deal (in the top 25 deals), but didn't have any this time around, according to Peters. But there were some smaller free-to-pay deals, and it closed a big free-to-pay deal in June that will show up in the second quarter of fiscal 2010 ending in August.

In terms of the economy, Whitehurst and Peters were not eager to call a bottom to the IT spending slowdown. They said that Red Hat's sales pipeline was strong, but as had been the case for the past couple of quarters, the sales cycle on deals had lengthened and some deals were requiring additional levels of approval to get done. Red Hat expects this stretching of deals to continue for several more quarters. That doesn't sound like a bottom, but it doesn't sound like the abyss either.

Red Hat ended the quarter with $855m in cash and equivalents and $567m in deferred revenue. That right there makes Red Hat a prize that more than a few hands are rubbing together over as IT vendors ponder an acquisition. If the future of systems is for integrated platforms, then Dell has to buy Red Hat, since it has no operating system, middleware, or database of its own. Red Hat had a market capitalization of $3.7bn at the close today, and you have to add in that cash (and maybe the deferred revenue) as well as a pretty hefty premium to buy it.

You're talking $6bn easy, possibly more. Or about in the same ballpark that Oracle is going to pay to acquire Sun Microsystems ($5.6bn net of cash and debts). I have trouble seeing how Red Hat's stock is worth anything near what it's valued at, relative to sales and earnings, but then again, by the same yardstick, most of the stocks traded on Wall Street are ridiculously overpriced.

Speaking of Sun, neither Whitehurst nor Peters wanted to do too much Oracle or Sun bashing ahead of the close of that deal, which is to be voted on (and presumably approved by) Sun's shareholders on July 16. But Peters said that Red Hat has not seen one deal lost because of Oracle Enterprise Linux (Oracle's clone of RHEL code and related support services), and Whitehurst said that the Sun-Oracle deal could be a good thing for Red Hat.

"I think there is still a lot up in the air, in terms of what is going to happen to hardware and what is going to happen to MySQL," said Whitehurst cautiously. "We are seeing a lot of interest from customers where they have too much spend concentrated with one vendor." And to that end, over the next year or two, Oracle's closing of the Sun deal could be a "positive" for Red Hat.

As for OpenSolaris somehow blunting the move away from Solaris toward Linux, Whitehurst said that Red Hat doesn't see OpenSolaris at all in enterprise accounts. So whatever good OpenSolaris has done in terms of revitalizing Solaris Unix, it has not necessarily stopped the move away from Solaris in accounts that, for whatever reason, have had enough and are picking Linux as their platform for the future.

Looking ahead, Peters said that Red Hat expected sales to be in the range of $178m to $180m in the second fiscal quarter, with operating margins in the realm of 23 per cent and earnings per share of between 14 and 15 cents on a non-GAAP basis. Red Hat has not changed its guidance for fiscal 2010. Back in March, when it reported its fiscal 2009 year-end results, Peters said sales would grow by between 10 and 13 per cent in fiscal 2010, to between $720m and $735m, and that diluted non-GAAP earnings would come in at between 58 and 62 cents per share. ®

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