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Revenue up, but Red Hat needs more JBoss focus

Company churns out another impressive quarter, with revenue rising 12 percent, but it may need to invest more in its middleware business to ensure future growth.

At the recent Red Hat Summit, company CEO Jim Whitehurst quipped that "flat is the new up," but he clearly wasn't referring to Red Hat. On Wednesday Red Hat announced another strong quarter, with revenue of $183.6 million for the company's second fiscal quarter of 2010.

That's a rise of 12 percent compared with the same period last year. Despite the company's against-the-grain performance in a weak market, however, it may need to invest more in its middleware business to ensure future growth.

But first, the good news. Of Red Hat's total revenue, roughly 85 percent, or $156.3 million, came from subscription revenue. That's an increase of 15 percent compared with the year-ago period. Putting this into context, IDC projects Linux subscription revenue to top $1 billion by 2012. Red Hat should claim virtually all of this at its current pace of growth.

Customers seem content to pay Red Hat for free software that they could get more cheaply elsewhere. While recent IDC data hint at hard times to come for commercial Linux vendors, it hasn't hit Red Hat. Not yet. The company is still a darling with CIOs.

And it may not for some time, with Red Hat reporting deferred revenue of $581 million, up 17 percent compared with the same period last year. The company is increasingly profitable, too. It reported net income of $28.9 million, or 15 cents a share, compared with $21.1 million, or 10 cents a share, for the year-ago quarter.

As part of its quarterly earnings call, Red Hat executives revealed a range of reasons to think its business is on track:

  • All top-25 customer accounts renewed, and at 120 percent of the prior year's value. Most customers are expanding their adoption of Red Hat, and more and more are upgrading to Advanced Platform.
  • Only three of its top-300 customers up for renewal didn't renew in the quarter, and two of those have returned to Red Hat after the quarter closed.
  • Two deals were over $5 million, while 10 deals hit $1 million. Red Hat EMEA (Europe, Middle East, Africa) closed its biggest deal ever in the quarter.
  • Of the top 30 deals, 23 included Red Hat Enterprise Linux (RHEL) Advanced Platform, and five included a JBoss component. This suggests that Red Hat's big customers are upgrading to Advanced Platform, according to Red Hat CFO Charlie Peters.
  • JBoss continues to grow much faster than the core RHEL business.
  • Deal length extended to 22 months from 19 months last quarter, reflecting
  • One former Red Hat customer, a large financial services company (almost certainly Credit Suisse), dropped Novell's SUSE Linux and returned to Red Hat with a big order in the quarter. Credit Suisse is one of the companies Novell pulled away from Red Hat by using Microsoft-subsidized coupons, but Peters indicated that the customer had returned because of Red Hat's superior value. It appears that Red Hat is a better value than free.
  • Red Hat is taking share from its competitors rather than seeing an increase in net new server purchases.

Despite the mostly sunny skies, Red Hat's slowing revenue growth remains a concern. The trend kicked off in 2005 and has continued apace since then despite a brief respite in 2007, as The 451 Group reports.

Of course, as Red Hat gets bigger, and as the economy remains stagnant, it's normal that Red Hat's revenue growth will slow.

But it's also normal that as it slows, companies like Red Hat will look for increased growth beyond their core businesses. Oracle is perhaps the most obvious example of this.

Red Hat doesn't need to get into video game consoles (e.g., Microsoft's Xbox) or hardware (e.g., Oracle's pending acquisition of Sun) or a variety of businesses far afield from its core infrastructure business. After all, Red Hat clearly has a lot of room to grow its JBoss/middleware business, and arguably needn't acquire its way to that growth.

But it does need to significantly change the way it views its channel partners.

Red Hat's traditional Linux partners are absolutely the wrong group to be selling its middleware offerings, a fact that took Red Hat some time to digest. Now, however, Red Hat seems to be getting the picture and has launched its Catalyst Program to sell turnkey open-source solutions through a growing ecosystem of value-added resellers (VARs).

Catalyst, however, is still in its infancy. It remains to be seen whether this program will stick, as Red Hat has moved away from ecosystem efforts like its Red Hat Exchange in the past.

For Red Hat's sake, it should stick with this one. Through Catalyst and other means, Red Hat needs to place more emphasis on the world outside of Linux. The company believes that virtualization and cloud computing are big opportunities, and they are, but these are mostly ways to build upon RHEL, rather than ways to extend its reach into fast-growing, diverse markets.

Red Hat is an execution machine and will undoubtedly be able to continue to grow its Linux business, and possibly to accelerate that growth again through enhanced investments in virtualization and cloud computing. But the real growth for the company is a bit higher up the stack in its middleware business.

Peters said that the company is investing significantly more in JBoss than RHEL, proportionate to the revenue each brings. That's good, but also obvious, given that Red Hat's JBoss business is comparatively small to its RHEL business. It may be time to invest even more in JBoss.