Morningstar | Red Hat Posts Continuing Growth Ahead of Deal Close; Raising FVE to $190
Red Hat reported healthy first-quarter earnings, with subscription revenue growth in the midteens--though at a decelerating pace year over year. We’ve raised our fair value estimate for the stock to $190 per share from $182 after accounting for the time value of money and anticipation that the firm’s acquisition by IBM will be approved. The IBM deal could close at any time--especially as the European Union is expected to approve the deal by the end of June. With shares trading at $188 per share, we recommend holding off on investing in this narrow-moat acquisition target.Over the first quarter, Red Hat’s revenue increased by 15% year over year to $934 million. Subscription revenue (which constitutes 87% of revenue) grew at 15% year over year--with particular success in application development offerings. Services revenue (which constitutes 13% of revenue) increased by 17% year over year. Over the quarter, the company improved the quantity of large deals, reporting 15% year-over-year growth in the number of $1 million deals. Red Hat’s profitability also improved, as the company reported non-GAAP operating margins of 21.7%, up 100 basis points year over year. Given the pending transaction with IBM, the firm didn’t host a conference call with analysts or provide an outlook for fiscal 2020.
While growth in subscription and services revenue is decelerating for Red Hat, we think the company’s cost advantage and network effect moat sources remain strong and, in isolation, will yield excess returns on invested capital once merged with IBM.
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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