Red Hat Has Never Been Hotter


Red Hat (NYS: RHT) put a whole bunch of feathers in its cap this week.

On Wednesday, the Linux vendor reported fourth-quarter earnings and revenue well ahead of analyst estimates. With 21% year-over-year sales growth to $297 million, Red Hat became the first open-source software specialist to deliver at least $1 billion of revenue in one fiscal year. Non-GAAP earnings also rose 12% to $0.29 per share.

Management also refreshed its buyback program with a new $300 million authorization. Red Hat used up $214 million of the previous $300 million buyback bill, so there's no guarantee that the entire repurchase program actually will happen. Management likes to take advantage of temporary dips for its open-market buys, the better to squeeze value out of the program.

And that brings us to Thursday's dramatic share price pop. Red Hat gained as much as 19.4% on these tremendous results. The stock now trades at 10-year highs. If you bought one enterprise software stock a decade ago, you could hardly have done better than going with Red Hat:

RHT Chart
RHT Chart

RHT data by YCharts.

Is that a totally fair comparison? Microsoft (NAS: MSFT) has suffered a lost decade with minuscule investor returns. Without that dividend, Mr. Softy would barely break even over 10 years. Then again, Red Hat arguably had a small hand in that outcome by stealing market share and mind share from Redmond.

And the story is pretty much the same when you put Red Hat up against Oracle (NAS: ORCL) or IBM (NYS: IBM) : Those tech giants have done fairly well for themselves and for investors, but nowhere near Red Hat's nearly 11-bagger returns. Yes, the Linux expert is taking scalps from Unix vendors, too.

A whole new world
All of this success stems from selling software that you can also get for free, bundled with fantastic support contracts. Red Hat is a veteran in the Linux game, and by far the largest vendor of open software into the enterprise market. (That software-and-service focus happens to be about 10 years old, in case you were wondering why I'm looking at decade-long time frames today.)

Before that shift, Red Hat's enterprise software was essentially the same as the free version, only with service level agreements and support contracts. Now, the enterprise package goes through tons of additional stability and quality testing, and each version is supported for up to 13 years. That's what it takes to keep IT directors happy.

And when customers are happy, investors will smile, too.

The road ahead
Yesterday is history but tomorrow is no mystery for Red Hat. CEO Jim Whitehurst sees several macro trends coming together to drive strong growth over the next several years, and he's doing his part to fan the flames. The first spark comes from cloud computing.

"As companies move toward the cloud, the first thing they do is replatform their applications onto a platform they feel confident can actually run in the cloud," Whitehurst told me in a phone interview. "They may just run that on bare metal in the data center, but they're getting there so they can trust that everything works in the longer term." And so it's a slow burn that starts with a few operating system sales on traditional hardware, paving the way for a cloud-based explosion of licenses later on.

Storage provides another serious catalyst. Red Hat is new to this game after acquiring data management expert Gluster in January, and isn't even taking orders in this market yet. But the potential for big sales is enormous: "The explosion of data, whether that's Big Data or just unstructured data, in combination with this replatforming to Linux to get ready for cloud, are probably the two largest catalysts." Whitehurst named Pandora Media (NYS: P) as a big customer for organizing unstructured data -- in this case oodles of media files to be tied together with track information in a database. It's not as easy as it may sound, and Whitehurst "would hazard a guess that virtually all de-duplication runs on Linux systems" already. He just wants a bigger slice of that revenue by providing the data-handling tools, too.

Red Hat is working hard to capitalize on these opportunities. For example, the mere act of acquiring Gluster and thus putting a respected brand with a big bankroll behind that software instantly made Gluster more attractive to business-class customers. The cloud and Big Data "are big, mega, secular trends that are working in our favor," according to Whitehurst.

That's why Red Hat deserves a trailing P/E ratio north of 80 (and a much less intimidating price-to-cash flow valuation): The company is not only riding two of the most exciting trends in computing today, but is making them feed off one another, too. Read up on Big Data in this free report and watch a video on the power of cloud computing, and see if you don't come away salivating over Red Hat's shares.

At the time thisarticle was published Fool contributor Anders Bylund holds no position in any of the companies mentioned. Check out Anders' holdings and bio, or follow him on Twitter and Google+. The Motley Fool owns shares of Microsoft and Oracle. Motley Fool newsletter services have recommended buying shares of and creating a bull call spread position in Microsoft. The Motley Fool has a disclosure policy.We Fools may not all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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Originally published