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Clouds of Doubt Rain Over Red Hat

NEW YORK ( TheStreet) -- Investors who once cast their lots on stocks having anything to do with the cloud and virtualization are adjusting their expectations. I don't blame them. Doubt now reigns over an industry once perceived as infallible Now the entire virtualization/cloud industry appears to be in transition. The culprit -- weak spending in enterprise IT.

These concerns have placed more attention on companies like Red Hat (RHT - Get Report), whose stock is down 13% this year. Investors fear that despite its strong Linux business, Red Hat lacks differentiation in areas such as middleware, the software that lies between an operating system and specific software applications. That will weaken Red Hat's leverage against two of the market leaders, Oracle (ORCL) and IBM (IBM).

Meanwhile, in its core open-source Linux business, Red Hat has to fight off rivals including VMware (VMW) and Citrix (CTXS). These companies are building up their capabilities with partnerships and entering related areas like mobile data traffic. Red Hat is being attacked from all angles. With its fiscal first-quarter earnings report due out Wednesday, management must provide answers and affirm that this company's still a good long-term bet.

The Street is looking for earnings of 31 cents per share on revenue of $359.8 million. The revenue number suggests year-over-year growth of only 1%, which seems odd given since Red Hats' revenue rose 17% in its fiscal fourth quarter and 18% in its third quarter.

I wouldn't be surprised if Red Hat were to miss its revenue target; I believe management hinted at this possibility in the fourth quarter.

Billings, also known as deferred revenue, is the metric that indicates the strength of future sales. Although billings were at decent levels of $454 million in the previous quarter, they were 3% shy of Wall Street's estimates. Accordingly, management's estimates for first-quarter revenue and earnings per share were below analysts' views.

While I don't there's a bigger underlying issue here, it doesn't bode well for confidence, either. Complicating matters is the stock's valuation still presumes perfection. That is despite the recent drop. If management can make up for the weak revenue with better profits, then an argument can be made for the stock's valuation, now close to 60 times earnings.

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