Red Hat Earnings: Great Outfit, Valuation Still Too High (RHT)

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Red Hat, Inc. (NYSE: RHT) is the old king of Linux but is now more of a virtualization and cloud solutions open source player for enterprises.  The company is almost always trading at a high market premium and Monday’s earnings are taking out a bit of the wind from the sails of this ship.  We did not just look at earnings and guidance but wanted to go deeper into forward valuations here to make a fair value assessment.  The short version: Red Hat needs to sell off some more, here’s why…

The company reported earnings of $0.28 EPS as revenues rose 23% to $290 million, but Thomson Reuters had estimates of $0.26 EPS $289.6 million.  Red Hat has a history of beating earnings expectations and often giving better upside guidance.  The company offered guidance of $0.26 to $0.27 EPS and sales of $289 million to $292 million for the quarter and Thomson Reuters had consensus estimates of $0.26 EPS and revenue of about $292.5 million.

What seemed to be another disappointment was the organic billings gain of about 23% rather than north of 25% expected, although it is that high-beta that makes “only 23% a disappointment.  Is Red Hat recession-proof?  No.  Still, the company is perhaps better positioned and better insulated against harder times than many peers.

Shares closed Monday at $46.05 and the 52-week range is $31.77 to $53.42. Shares were down some 8.6% at $42.06 on almost 900,000 shares in the after-hours session on Monday and Tuesday’s trading indications are not much better so far.

The big issue here is how high of an earnings multiple Wall Street is willing to assign here.  Thomson Reuters has estimates at $1.05 EPS for fiscal February 2012 and estimates are $1.15 EPS for fiscal February 2013.  We are only one-quarter out from the fiscal year, so using a blended earnings estimate still generates a stock valued at around 39-times earnings even taking the after-hours share price drop into consideration.  Its market value is also still north of $8 billion after the drop, giving it a forward revenue multiple of about 6.6-times on a blended basis.

The end game… Red Hat is a great company, but the stock needs to get back into the $30′s before “growth bargain hunters” step back in.

JON C. OGG

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