Investors Flatten Red Hat

Wall Street analysts noted disappointment in the Linux software outfit's growth

Red Hat (RHAT) shares tumbled more than 23% on Sept. 27, after the Raleigh (N.C.)-based Linux and open source solutions provider announced disappointing second quarter results.

Red Hat said late Sept. 26 that its net income for the three months ended Aug. 31 amounted to 5 cents per diluted share compared with 9 cents per diluted share during the same period last year, after accounting for options related expenses.

Red Hat announced recent acquisitions this year including of JBoss, which specializes in software distributed at little cost over the Internet. "The second quarter was one of intense focus on integrating our recent acquisitions in Argentina, Brazil, India and, of course, JBoss," stated Charlie Peters, Executive Vice President and Chief Financial Officer, in a press release. "We expect operating results and cash flow will improve in the second half of fiscal 2007 since much of the heavy integration work is behind us already."

Red Hat highlighted mostly positive results in its press release: subscription revenue was $84.9 million, up 56% year-over-year and 19% sequentially, for example. But Wall Street players noted less stellar results, and the stock was plunging 23.4% to $20.17 per share in Nasdaq trading Wednesday.

"Given Red Hat's disappointing core Linux growth performance in the second quarter the stock is likely to be back in the penalty box until they post steady results," Credit Suisse First Boston analysts Jason Maynard and Bryan McGrath said in a research note. After adjusting for a one-time addition related to JBoss's deferred revenue, the company's total billings -- in other words, its new business -- of $112 million came out $11 million below CSFB's $123 million estimate. Red Hat's cash flow of $44 million was below CSFB's estimate of $51 million. But the analysts added that the shortfall most likely reflects a management execution issue rather than a major downtick in Linux adoption.

CSFB wasn't the only firm to wonder about the company's growth. "Although we favorably view Red Hat's progress towards integrating JBoss, we see possible revenue growth deceleration," said Standard & Poor's Corp. analyst Clyde Montevirgen in a research note. (S&P, like, is owned by The McGraw-Hill Companies.)

Goldman Sachs lowered its 12-month target price on the stock to $20 from $22, citing disappointment in the company's billings. Analyst Rick Sherlund expects controversy about how much the company's billings shortfall resulted from short-term sales force transition issues associated with the JBoss acquisition, and how much might have been a slowing in the market for Linux. Sherlund also warned that when Oracle (ORCL) holds an analyst meeting on Oct. 26, the software giant could mention plans to enter the market with a rival product.

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