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What's the Deal With Red Hat?

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( TheStreet) -- Software giant Red Hat (RHT - Get Report), a leader in open source technologies as well as cloud computing has now become one of these names that have placed me in the predicament of trying to justify its lofty valuation to potential investors. I'm not going to pretend that this a "rock and hard place" type of situation, but how do you rationalize taking a position in a stock sporting a P/E of 80 after it has already gained 50% on the year? It gets even more remarkable when you consider that a competitor such as VMware (VMW - Get Report), which by many standards already qualifies as expensive but trades at a multiple that is 14 points less


As well as Red Hat has performed in its most recent quarter, making a case to buy the stock is not as easy as it seems -- particularly when the word "valuation" comes at the forefront of the discussion. Having said that, I also appreciate that valuation concerns have rarely (if ever) mattered to tech companies. Because as noted, VMware sports a P/E of 66 while others within the space such as (CRM - Get Report) have sported P/Es that are off the charts -- literally. In trying to keep things in perspective, I am starting to warm up to the idea that perhaps for Red Hat, I might have been a tad too skeptical that it can grow into its valuation. What caused this sudden change was the improvement is showed in its Q4 results after having reported what I thought was a less than stellar Q3.

A much better Q4

The company recently reported impressive year-over-year growth rates in several key areas -- which include revenue, operating income, billings as well as operating cash flow, all of which topped not only last year's Q4 performances, but the full year as well. Gross profit arrived at $253.4 million -- representing an increase of 24.2% year over year from $204.2 million. Gross margin expanded 190 basis points to 85.3% in the quarter. The company said that these results were largely attributable to an increase in services gross margin as well as a better revenue mix.
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