Morningstar | Red Hat Persists Amid Free Linux Options; Shares Fairly Valued
Red Hat saw a decent quarter due to traction in OpenShift and Ansible, although there was decelerating growth on the Red Hat Enterprise Linux side, owing to subscription renewal lag. Full-year revenue guidance was lowered because of expected currency headwinds. As Red Hat maintains a strong focus in worthy emerging technologies, such as its container products, and appears to stand its ground amid free supported Linux OSs, we are maintaining our narrow moat rating and $145 fair value estimate. Red Hat is currently trading at our fair value estimate.Second-quarter revenue rose 14% year over year to $823 million, slightly below our internal estimate. In Red Hat’s subscription segment, infrastructure offerings decelerated to 8% year-over-year growth, mainly driven by RHEL. Management expects a reacceleration of RHEL growth, given more subscriptions coming up for renewal next year, which we expect to be true, as Red Hat’s switch to multiyear subscriptions is expected to catch up with the company by then. Application development and emerging tech subscription revenue grew by more than 30% compared with the second quarter last year, owing to popularity in OpenShift and Ansible, which overcompensated for middleware’s lacking performance, which it is cannibalizing. In the training and services segment, growth came in at 17% year over year due to training and consulting for emerging tech products.
We’re encouraged by Red Hat’s ability to maintain its value proposition in the public cloud even with free supported Linux OSs, such as Amazon Linux. Out of Red Hat's largest contracts that were up for renewal, 24 out of 25 were renewed in the quarter, and the sole nonrenewal was due to a switch to an on-premises OS provider, not to the likes of Amazon Linux. We’re less concerned with losses in on-premises server OSs, as it is estimated that 65% Linux deployments are paid, which we believe is significantly higher than on-premises paid deployments. While we are keeping a close eye on erosion from adoption of free supported Linux OSs, we believe Red Hat’s value proposition remains strong in its mission-critical environment.
Red Hat is a provider of open source software solutions, using a community-powered approach to develop and provide operating system, virtualization, management, middleware, cloud, mobile and storage technologies. The company provides its software offerings primarily under annual or multi-year subscriptions as well as on-demand through its certified cloud and service providers. The company's products and services include: Infrastructure-related offerings, which consist of Red Hat Enterprise, Red Hat Satellite, and Red Hat Virtualization; and Application Development-related and Other Emerging Technology Offerings, which consist of Red Hat JBoss Middleware, and Other Emerging Technologies.
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