1Q2012 Earnings Review: In its reported results, Red Hat , Inc (RHT) showed that the company continually outperformed analysts' expectations for the 6th straight quarter in terms of revenue and earnings growth. 1Q2012 revenue sustained a historical growth and rose by 19% year over year in 1Q2012 (22% in constant dollars) to $297.01 million, beating analysts' consensus of $291.22 million. In addition, the bottom line performed equally well with the EPS rising by 15% YoY in 1Q2012 to $0.29, beating the street estimate of $0.27.
Billings Growth: However, the billing growth, a key indicator of RHT's future business performance, was unable to meet analyst expectations, largely due to seasonal and FX effects. Billing revenue growth was 16% (20% in constant dollars) in 1Q2012 compared with analyst expectations of 20%.
Guidance: Owing to expected weakening global demand and further strengthening of the U.S. dollar against other currencies, the management retreated Q2 revenue forecasts to $320-$322 million from analyst expectations of $330 million. In addition, the management also reduced the full-year forecast range from $1.33-$1.35 billion to $1.32-$1.34 billion.
Analysis: Overshadowed by the news of a decline in billings growth, the stock was down more than 10% in after-hours trading. However, we believe that the market overacted on the shortfall in billings growth, as the current market estimates were already unrealistic. The billings growth has not slowed if one excludes the FX impact. The company beat analyst revenue and earnings expectations, even in the current grim economic environment, which signifies the strong competitive positioning of the company among tough rivals like Microsoft (MSFT), IBM, Oracle (ORCL) and others. Our views are aligned with the management and we believe that the U.S. dollar may continue to strengthen, and corporate spending on enterprise systems may slow down in a deteriorating economic environment, which will exert downward pressure on near future earnings. However, in response to investors' concerns surrounding Europe, the management unveiled that it is experiencing a strong demand from Europe amid the poor economic environment; thanks to competitive pricing. Therefore, we think that the company may be able to completely offset the negative vibes relating to Europe by taking advantage of Europe's deteriorating economic environment due to a value-driven pricing structure.
Growth in Bookings: The company disclosed in yesterday's earnings conference that it recorded more bookings over bills, and booking grew highest in 1Q2012 over the past five years. The company reported, "In 1Q2012, we had 25 deals of $1 million or greater, nearly double from the prior year first quarter." Furthermore, the management disclosed that the average deal length has remained consistent at 21 months in the past five quarters.
Valuation: RHT is currently trading at a forward multiple of 46x to earnings and 8.5x to sales. The stock is trading expensive compared with rivals as a result of continuous positive earnings growth surprises in the past five quarters and consistent >20% growth rate in the past seven quarters. We expect RHT to continue the historical growth trend in the future owing to continuous launch of new innovative software, geographic expansion, competitive pricing, and wide adoption of cloud computing among enterprises.
RHT | IBM | HPQ | MSFT | ORCL | VMW | |
Price (June 20, 2012) | $ 50.14 | $ 198.78 | $ 21.16 | $ 30.93 | $ 28.49 | $ 93.47 |
P/E | 46.43x | 13.21x | 5.21x | 11.54x | 11.77x | 34.62x |
P/S | 8.58x | 2.12x | 0.34x | 3.52x | 3.81x | 8.69x |
MRQ Sales YOY Growth | 21.3% | 0.3% | -3.0% | 6.0% | 1.3% | 25.1% |
D/E (MRQ) | 0.0% | 154.8% | 72.9% | 17.4% | 37.4% | 8.7% |
Operating Margin (TTM) | 17.6% | 19.7% | 6.1% | 38.0% | 36.9% | 20.1% |
ROE | 10.9% | 74.0% | 12.6% | 38.2% | 23.8% | 17.2% |
Business Description: Red Hat has been the best company so far in developing Linux embedded systems, servers, and enterprise software. Red Hat is popular among large enterprises due to its power-efficient fast systems. In addition, the open source nature of Linux enables developers and enterprises to tweak the software according to their needs, which is one major competitive advantage that Red Hat has over its rivals. Red Hat's latest offering, rich cloud computing systems, are high in demand, as more and more corporations call for private cloud computing networks. In addition to providing enterprise software systems, the company also sells subscriptions to upgrades, provides bug fixes, and help desk support. 55% of subscription bookings came from the U.S. in 1Q2012, while 25% came from EMEA, and 20% from Asia Pacific. The company operates in more than 70 countries and is largely exposed to FX risk. The recent strengthening of the U.S. dollar against most of the currencies has trimmed down the earnings of RHT.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
