Thursday, September 25, 2008

Red Hat (RHT) Opportunities, Dangers

Red Hat is doing well navigating its dangers and opportunities.

Yesterday Red Hat (RHT) released their numbers and held the analyst conference for their fiscal 2nd quarter 2009, which ended August 31, 2008. Revenue was $164.4 million, up 5% from $156.6 million in Q1 and up 29% from $127.3 million year-earlier.

For more financial details, management comments, and answers to questions posed by analysts, just go to my Summary of the Red Hat September 24, 2008 Analyst Conference.

Red Hat is now the best known, and largest in terms of revenues, open source software company. Its two best known products are Red Hat Enterprise Linux and JBoss middleware (which helps Java software applications run and interconnect with clients).

In one sense Red Hat is still a small company. Proprietary software companies like Oracle and Microsoft have quarterly revenues in the multiple billions of dollars, dwarfing Red Hat revenues.

There are really only two major operating systems fighting for market share, Linux and Microsoft Windows [caveat: there are also Sun Solaris and Apple OSX, but they are closely related to Linux]. There is only one Microsoft, but there are many Linux vendors, so Red Hat has to fight for its share of the Linux market, which is smaller to begin with.

Linux is open source, which means you can get it for free and run it without a license. That may not seem like much of a business model. The Linux companies Like Red Hat make their money from offering support for their clients. There just aren't enough Linux experts to go around, and it makes sense to centralize certain tasks. Most corporations that use Red Hat say they are getting a bargain when they get reliable, tested solutions from Red Hat and pay for support. Support includes upgrades and security and bug fixes and the ability to get a question answered by experts.

Microsoft has the advantage of being able to spread out its research and development costs over a large number of installed systems. Red Hat and other Linux companies in effect spread out their development costs by sharing code innovations, and by getting free inovations from clients and independent Linux coders.

Companies that make money from technical support now offer Linux support that competes with Red Hat. This includes hardware vendors like HP and IBM, as well as software vendors like Oracle. The Oracle case is particularly interesting. Oracle claims that it provides its customers with a duplicate of Red Hat Enterprise Linux for free, and then charges for support. Two years ago when this was announced Wall Street thought Red Hat was doomed.

In fact, Oracle had endorsed the Red Hat product. You can bet that Oracle software runs well on Red Hat Linux. And while Oracle has great products, it has angered plenty of competitors and clients over the years. Corporations may not want the convenience of having a single software vendor when it comes with a price tag that may be jerked up, leaving them no alternative but to pay. Red Hat, especially now that it provides an enterprise version of JBoss Java middleware, provides a highly reliable alternative to being married to Oracle (or IBM, or HP).

The use of open source software is growing rapidly, especially for server operating systems, datacenters, and Internet computing. Red Hat continues to capture a significant share of this growth.

Sometimes computer giants simply crush smaller companies that they cannot buy by underpricing them. But underpricing Red Hat to capture its smallish market share would mean a major devalutation for Microsoft or Oracle. Red Hat has $1.4 billion in cash, a tremendous amount of money considering their overall size. Its clients appear to be very loyal.

It may take another year to completely get JBoss revenues rolling in. If I were Red Hat, my next acquisition would undercut one of the main selling points of Microsoft, Oracle, IBM and Sun. I would buy an open source, database system and make it enterprise-ready. Given the stiff pricing of Oracle and Microsoft database software, I am sure many businesses around the world would appreciate that.

I own some Red Hat stock. All technology companies are subject to competition and should be treated as risky (even when they have great potential). So ...

Keep diversified

More data:

My Red Hat analyst conferences page

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