Linux Distributor Red Hat: Nice Business, Expensive Stock (RHAT, MSFT)

 |  Includes: MSFT, RHT
by: Douglas McIntyre

RedHat (RHAT) announced earnings today for the fiscal fourth quarter and full year 2006 which ended February 28. Quarterly revenue came in at almost $78 million, up 37% from the same quarter last year. For the year, revenue was $278 million, up 42%. Operating income growth was even more impressive, rising 116% for the year to $58 million. The company forecast that it would do about $83 million in the current quarter, which, according to Reuters was a bit of a disappointment.

RedHat licenses and supports open source software, particularly Linux. This includes operating systems, middleware and management solutions.

Linux is in its prime. It is the logical alternative to Microsoft (MSFT) products, and, due to the large community that contributes to Linux without charging for core development work, Linux is, in most cases, less expensive to deploy than Microsoft solutions.

RedHat has had an astonishing run this year, from just over $10 to $31. After hours today, it traded slightly below $28. This still gives the company a price-to-sales ratio of over 20 times. Microsoft's price-to-sales number is 6.8x.

When Microsoft was in its real growth spurts, the company was putting up revenue increases like RedHat is now, but on much, much bigger numbers. From 1996 to 1997, revenue at the software giant grew from $8.8 billion to $11.4 billion. Operating income grew from $3.1 billion to $5.1 billion. Investors tend to forget how formidable the Microsoft machine was.

RedHat has a strong business and open source software is likely to continue to grow as an alternative to Microsoft. But, until the company can show growth off of much bigger numbers, the multiples are too high.

RHAT 1-yr Chart

Douglas A. McIntyre was the Editor-in-Chief and Publisher of Financial World Magazine. He was also president of which was the 10th most visited website on the internet, according to MediaMetrix. He has been chief executive of FutureSource, LLC and On2 Technologies, Inc., and has served on the boards of Edgar Online and He does not own securities in companies he writes about.