THE DAY AHEAD: Red Hat has that visibility thing

Larry Dignan
4 min read

COMMENTARY--Linux leader Red Hat's outlook for its upcoming fiscal year could leave Wall Street fretting about revenue growth, but investors should take what they can get. Red Hat seems to have something few tech companies have these days--visibility.

Yes, visibility--that vague concept that a company can reliably predict future quarters. Judging from the last dozen or so conference calls I've listened to, it's clear that tech CEOs are flying blind. These executives can't predict the next quarter, fiscal year or even what business will be like next week. Silicon Valley execs can't even predict if the electricity will stay on.

Enter Durham, N.C.-based Red Hat (Nasdaq: RHAT), which sells services and support based on the open source--and free--Linux operating system. Chief Financial Officer Kevin Thompson on Thursday said the company expects to report a fiscal 2002 profit of 10 cents a share excluding charges, or 8 cents a share with charges, on sales of $140 million. According to First Call, analysts expected Red Hat to earn 4 cents a share on sales of $152.4 million for fiscal 2002. Simply put, Red Hat sees better-than-expected earnings on weaker-than-expected sales.

You'd think analysts would be happy that a company could even provide an outlook given the slowdown in information technology spending, but the Wall Street wonks were worried about revenue growth on the company's conference call.

It's a jump ball between cheering the bottom line and worrying about the top line, but I'd say you should cut Red Hat some slack.

Here's why:

     The company has visibility into its business;
     Red Hat is delivering on the goals it has set;
     Red Hat is living up to its original Linux hype.

Sure, you could argue that Red Hat is delusional about its predictions for the fiscal year, but the company has met expectations in its short history. Either Red Hat is gutsy with its outlook or it actually has visibility. Either way, I'm on board.

You could choose to nitpick over Red Hat's fourth quarter, but take a respite and enjoy some positive news for once.

Just for argument's sake, I'll detail the Red Hat worries.

The company topped estimates by breaking even in its fourth quarter, but reported sales of $27 million. That sum topped consensus expectations, but fell short of some analysts' projections. And that $27 million included $5.5 million from the recently acquired Planning Technologies, a network infrastructure consulting firm. Take out Planning Technologies and Red Hat's revenue fell well short.

Prakesh Patel, an analyst at W.R. Hambrecht, called Red Hat's results a mixed bag, lowered his 2002 revenue estimates and kept a "buy" rating on the stock. Without the Planning Technologies acquisition, Red Hat would have had a loss of a nickel a share on revenue of $21.5 million, said Patel.

Nevertheless, the results show a company that's focused on the bottom line, and that's not a bad thing in tough times. CEO Matthew Szulik portrayed a company that's intent on making its acquisitions pay off to boost earnings. Red Hat expects to be profitable in its fiscal first quarter. That's impressive since Red Hat doesn't have to hurry--it's sitting on $303 million in cash and long-term liquid investments.

Will Red Hat's outlook stick?

Red Hat execs think so. Red Hat, which has a decent mix between subscription and services sales, said its outlook is cautious to reflect the IT malaise. Partnerships with Dell Computer (Nasdaq: DELL) seem to be leaving Red Hat with revenue that's "pretty predictable" for the next quarter. And an alliance with IBM (NYSE: IBM) is just getting rolling. CEO Szulik said Red Hat will become "more and more engaged with IBM."

OK, maybe I'm just delusional and desperate for good news--I'm rooting for a company that sells free software. But consider the track record here. Red Hat went public in August of 1999 with barely a speck of revenue, but the stock went nuts even though the company didn't accomplish a thing. By the end of 2000, Wall Street had gone bonkers over Red Hat and its merry band of Linux stocks. Nevermind that Linux was just in its infancy.

In the spring of 2000, Red Hat began sounding like a real company with real financial targets. Despite improving fundamentals, the stock still fell. In June 2000, Red Hat moved up its profit target by a year. Wall Street continued to yawn.

Now Red Hat meets its objectives and focuses on growing earnings. The stock still resides near 52-week lows. Sometimes a company's performance and the stock price just don't match. TDAIN
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