I can't knock the bear who insists on raising this point. Management needs to sort this part out. Margins can't continue to contract and then expect concerns about valuation to go away. Investors will want to know what they're paying for.
But given Red Hat's solid beat on the top and bottom lines, I'm now willing to look slightly the other way.
It was certainly encouraging that Red Hat's CEO, Jim Whitehurst, didn't appear too concerned about the companies competitive situation.
In an interview
Chris Ciaccia, Whitehurst cited (among other things) Red Hat's plans to enter new categories including Open Shift and Open Stack. He also noted:
"The power of Open Stack is that it has massive participation. It has everyone from Microsoft to VMware (VMW), to Hewlett-Packard (HPQ) to us participating in it. An industry is coalescing around an open source standard. There's a lot of momentum and a lot of interest in Open Stack, but it's still early days."
Whitehurst has essentially given investors reason to be patient. Investors have long feared that despite the company's strong Linux business, Red Hat lacked differentiation in areas such as middleware, which is the software that lies between an operating system and specific software applications. Open Stack seems to be the answer.
If Red Hat can duplicate its Linux success into these new initiatives, investors will end up doing well. But these are some pretty big ifs. Both Oracle and IBM have equal motivation to enter these markets. I'm not discounting Red Hat's capabilities. But I also understand that the company is behind both IBM and Oracle in some pretty meaningful enterprise categories.
These realities have prompted investors to sell the stock this year by as much as 13%. The stock still hasn't entered my value threshold yet. But after a solid first-quarter earnings report, which included new strategic initiatives, I think Red Hat deserves a chance -- even if it is on the basis that "the worst is over."
It's not a glowing endorsement. But with an improving enterprise spending environment and a market that continues to show a strong bias towards cloud-based tech companies, sometimes that's all you need.
At the time of publication, the author held no position in any of the stocks mentioned
This article was written by an independent contributor, separate from TheStreet's regular news coverage.