Red Hat Has Investors Concerned About Its Future: What Wall Street's Saying

NEW YORK (TheStreet) -- Software maker Red Hat  (RHT) concerned analysts Friday with lower-than-expected billings, an indicator of future revenue for the company.

In results released after the markets closed Thursday, the Raleigh, N.C.-based software maker said billings for the first quarter were up 11% to $449 million. That was 2% shy of analysts' consensus of 13%, according to Bloomberg, which tracks this data.

The consensus contained "a very broad spread of estimates" from analysts, Red Hat Chief Financial Officer Charlie Peters said in response to questions about the company's billings on a conference call Thursday.

Meanwhile, deferred revenue balance -- revenue the company is expecting but has not yet collected from clients -- grew 13% year over year to $1.44 billion. Analysts also indicated that the company's operations overseas have been hurt by a strong U.S. dollar.

Shares of Red Hat were higher in early Friday trading, gaining 2.2% to $80.23, despite the concerns from Wall Street. Year-to-date, shares have gained 13.5%, broadly outpacing both the Nasdaq (QQQ) and the S&P 500 (SPY).

Despite the concerns about billings, many analysts were upbeat on the company's long-term outlook.

Red Hat reported earnings of an adjusted 44 cents per share on revenue of $481 million, beating a Thomson Reuters survey of analysts that predicted earnings of 41 cents per share on revenue of $472.59 million.

That represented a 3.6% increase over revenue from the fourth quarter of 2014, which was $464 million, and a 14% increase from the same quarter a year ago.

The company attributed the results to increasing demand for its open-source and cloud-based software. Revenue from subscription-based software purchases was up 14% over a year ago, the company said.

Despite worries about billings and foreign exchange, analysts mostly maintained or upgraded their ratings and price targets, with several predicting that the company will continue to outpace its competitors, such as VMware (VMW) and Oracle (ORCL). That dominance, they argued, will make a position in Red Hat a good investment in the long term.

Here's what a few had to say.

Credit Suisse analyst Sitikantha Panigrahi (Outperform, $84 price target)

"Red Hat's Q1 results reinforces our thesis that the continued momentum of RHEL, coupled with growing adoption of open source in enterprises, has enabled Red Hat to increasingly upsell its emerging products. In the long term, we believe that Red Hat is well positioned to benefit from the growing adoption of OpenStack and the cloud computing trend. Therefore, we reiterate our Outperform rating and raise our target price to $84 from $78."

Jefferies analysts John DiFucci and Brad Zelnick (Hold, $72 price target)

"F1Q headline numbers were largely in line or better than expectations, though deferred revenue was light. However, our calculation of new subscription ACV was flattish from a year ago, though it was against a difficult comp. F1Q results also benefited from a one-time $5M benefit to subscription revenue that was likely not in prior guidance. Guidance was a bit below expectations on the bottom line for F2Q, while it was left intact for the year."

MKM Partners analyst Kevin Buttigieg (Neutral, $75 price target)

"RHT delivered solid F1Q16 results with revenues and EPS ahead of expectations. Adjusted billings growth of 19% ex-items edged our 17% estimate even though it was hampered by a reduction in average contract duration, a reversal from the past two quarters where duration aided billings. Nevertheless, the shares traded off modestly in after-hours trading as billings missed some Street expectations and guidance was not raised. While neither seems overly concerning fundamentally to us, the investor reaction likely illustrates the high level of expectations currently embedded in RHT shares. So, while RHT continues to outpace all other infrastructure software vendors, that positive performance appears to be well reflected in a 20x EV/cash flow valuation, and we remain concerned that RHT could see billings growth rates decelerate from a decline in average contract duration, the end of the Windows Server 2003 upgrade cycle, and tough compares."

Cantor Fitzgerald analyst Brian J. White (Buy, $90 price target)

"In our view, the combination of healthy trends in the core business with RHEL and strong growth in emerging technologies is increasingly positioning Red Hat as the go-to player in the open source software world, a trend that we believe is poised for continued momentum over the coming years. At the same time, Red Hat's expanding reach provides the company with more financial levers to pull and offers investors more reasons to own the stock."

JPMorgan analyst Mark R. Murphy (Overweight, $85 price target)

"We remind investors that Red Hat remains on the cusp of significantly disrupting additional areas of the data center with OpenStack and the rest of its broadening product portfolio, all while carrying a trajectory in the mid-teens-plus range and expanding margins. Additionally, currency comparisons should ease after FQ2, providing easier y/y comparisons."

Pacific Crest Securities analysts Rob Owens and Ben McFadden (Sector Weight, no target)

"Red Hat remains well positioned for the long term, in our view. Results demonstrated solid fundamentals in the Linux market and traction in its emerging businesses. Despite the upside to our estimates, guidance for the year remained in line (albeit with bias to the high end) and we are raising estimates only modestly. In addition, shares have risen significantly over the past year, which leaves us searching for a better entry point, especially given that flat operating-margin guidance is likely to dampen near-term free cash flow growth."

JMP Securities analysts Greg McDowell and Rishi Jaluria (Outperform, $81 price target)

"We like Red Hat as we believe it will continue to be a 'share gainer' against Unix and Windows, and we feel that JBoss and OpenStack can become meaningful contributors to the business over the next few years. We raise our FY16E non-GAAP EPS estimate from $1.81 to $1.82 (consensus $1.81), and maintain our FY17E (CY16E) non-GAAP EPS estimate of $2.18 (consensus $2.15). Red Hat trades at 18x EV/CY16E FCF, while our new $81 price target implies an unchanged EV/CY16E FCF multiple of 19x, applied to our increased CY16 FCF estimate. Our 19x multiple is in line with Red Hat's constant currency revenue growth rate."

Deutsche Bank analyst Greg Poole (Hold, $75 price target)

"Red Hat (RHT) posted solid 1QF16 numbers, highlighted by 22% c/c revs growth (in-line with last quarter and above the 20% guidance), 20% c/c billings growth (using the DR change off the cash flow statement and FX-adjusting revenues) and a beat in terms of non-GAAP operating margins (23.6% against guidance of 22%), OCF (+27% against our +7% estimate) and non-GAAP EPS ($0.03 beat against guidance, $0.01 without one-time factors). This was another clean [quarter] and we attribute the modest share price weakness in the aftermarket to high expectations and the deceleration in reported billings growth (before adjusting for FX). We maintain our Hold rating."

Barclays analyst Raimo Lenschow (Overweight, $85 price target)

"Red Hat met or exceeded consensus on most metrics and showed relative strength in both its core (+19% y/y in constant currency) and emerging offerings (+44% y/y in constant currency). Total billings increased 11% y/y as reported, although we believe when adjusting for the impact of shorter duration (20 vs. 21 months in 1Q15), and backing out a one-time cloud service provider adjustment, billings growth would have been closer to the mid-to-high teens range. Profitability and cash flow were also better than the Street forecasted, supporting our view that there is room for ongoing margin improvement in the model. Although some investors may be disappointed by the headline figures, we believe Red Hat's underlying results were quite solid and supportive of our long-term investment thesis."

TheStreet Ratings team rates RED HAT INC as a Buy with a ratings score of B. TheStreet Ratings Team has this to say about their recommendation:

"We rate RED HAT INC (RHT) a BUY. This is driven by a number of strengths, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its robust revenue growth, growth in earnings per share, increase in net income, good cash flow from operations and solid stock price performance. We feel its strengths outweigh the fact that the company is trading at a premium valuation based on our review of its current price compared to such things as earnings and book value."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • The revenue growth came in higher than the industry average of 5.0%. Since the same quarter one year prior, revenues rose by 15.9%. This growth in revenue appears to have trickled down to the company's bottom line, improving the earnings per share.
  • RED HAT INC has improved earnings per share by 8.3% in the most recent quarter compared to the same quarter a year ago. The company has demonstrated a pattern of positive earnings per share growth over the past two years. We feel that this trend should continue. During the past fiscal year, RED HAT INC increased its bottom line by earning $0.97 versus $0.93 in the prior year. This year, the market expects an improvement in earnings ($1.81 versus $0.97).
  • The net income growth from the same quarter one year ago has significantly exceeded that of the S&P 500 and the Software industry. The net income increased by 5.8% when compared to the same quarter one year prior, going from $45.07 million to $47.70 million.
  • Net operating cash flow has increased to $217.38 million or 17.70% when compared to the same quarter last year. The firm also exceeded the industry average cash flow growth rate of -17.89%.
  • The return on equity has improved slightly when compared to the same quarter one year prior. This can be construed as a modest strength in the organization. Compared to other companies in the Software industry and the overall market on the basis of return on equity, RED HAT INC has outperformed in comparison with the industry average, but has underperformed when compared to that of the S&P 500.

You can view the full analysis from the report here: RHT Ratings Report

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