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2HRS2GO: Red Hat grows up -- and Wall Street says bye

Today's Red Hat (Nasdaq: RHAT) action provides the best evidence yet that Linux has lost its momentum on Wall Street.

Shares of the Linux OS distributor dropped this morning, renewing their sustained slide of the last two and a half months after a slight interruption last week. Today's fall stands against the overall Nasdaq Composite Index, and comes despite decent fourth quarter results.

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This morning's report started out well enough. Red Hat's 4-cents-per-share loss beat the First Call estimate, unlike last quarter when the company missed by a penny. Quarterly revenue of $13.1 million ran slightly ahead of the company's public forecast. Hal Covert made a solid, if unremarkable, conference call debut as Red Hat's chief financial officer, replacing Manoj K. George.

Red Hat's analyst calls have come a long way from the first one in September, when executives that didn't seem to take financial reporting seriously. How else to explain the confusion between "revenue" and "earnings" on that second quarter call?

By contrast, the latest call was exactly the kind of thing you'd like to hear from a company that's growing up. Part of the maturity probably comes from the appointment of Covert last month (Memo to Red Hat: George is still listed as CFO on your website) and the elevation of Matthew Szulik as CEO last November to take the reins from Red Hat co-founder Robert Young, who remains chairman.

Want more proof of Red Hat's increasing Wall Street Establishmentarism? Covert outlined 5-year financial targets that call for 100 percent annual revenue growth, which projects to $1.36 billion in fiscal 2005 revenue. The company sees a long-term gross margin of 70 percent, which would be a vast improvement over fiscal 2000's 46 percent.

The Red Hat Five Year Plan calls for 30 percent operating margin. Covert expects that by the end of 2002, Red Hat will reach cash flow positive and profitable.


So much for being a hot concept company. Now Wall Street can measure Red Hat against a tangible target. Now Wall Street can measure Linux against a dollar standard instead of vague hopes of market share and server installations and open source idealism.

And once real sales and earnings come into the picture, the momentum traders jump over the railing and swim for the next hot ship. Good traders commandeer the lifeboats.

Yet Red Hat isn't doing so badly for a tech company that's been public for less than a year. The company expects 75 percent of revenue growth in fiscal 2001 will be internal, with the rest coming from acquisitions. Current analyst models on Wall Street basically reflect the company's view for the next year, Covert says.

Neither Szulick nor George nor anyone else can do much about Wall Street sentiment, so there's no point in berating them. But the fact that today's report couldn't boost RHAT shares or at least sustain their recent gains shows how much air still lies underneath the stock, even after a 58 percent drop since early January.

Even now, Red Hat carries a market cap of $7.6 billion, or nearly 180 times last year's sales. Compare that to a certain OS vendor with the ticker symbol MSFT: Microsoft, -- a company with the most solid track record of any tech company of the last 20 years and likely to grow strongly in some form regardless of the outcome of the antitrust trial -- carries a price-to-1999-sales ratio of roughly 28.

Unlike Microsoft, Red Hat faces some headstrong challengers in its OS space, including Corel (Nasdaq: CORL) and the newly public Caldera (Nasdaq: CALD). And the entire Linux collective, let alone Red Hat by itself, has a long way to go before claiming Microsoft-like dominance.

One company certainly won't do it in five years. 22GO>