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Old 04-02-2008, 01:46 PM   #1
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Smile Red Hat Linux Thrives As IT Budgets Shrivel

March 28, 2008 | By Eugene Bukoveczky

Shares of tech bellwether Oracle (Nasdaq:ORCL) took in on the chin Thursday, sliding 7% in reaction to weaker than expected sales. Investors have long seen Oracle as a defensive play but the sales disappointment is now being interpreted as a sign that the economic slowdown is taking a bite out of corporate IT budgets. But for one company, at least, there might just be a small silver lining among the gathering dark clouds. Red Hat Linux (NYSE:RHT) has made a name for itself by giving away software for free, and when money is tight everyone loves a bargain.

Revenge of the Nerds
As a leading proponent of the open-source software development model, Red Hat freely distributes the enterprise software developed by legions of part-time software developers working for free to its corporate clients. This is a stark contrast to industry giants like Microsoft (Nasdaq:MSFT), Hewlett Packard (NYSE:HPQ) and IBM (NYSE:IBM). Red Hat makes money by charging its customers for upgrades, maintenance and support via subscription agreements.

The system works because Red Hat has managed to gain the confidence of the corporate IT community by having imposed a professional business model over what would otherwise be the anarchy of a nerd-driven ad hoc software development exercise. By so doing, it gains an advantage of being able to access a software development process that works at a faster pace and lower cost than the proprietary versions employed by its competitors. (For related reading, check out Economic Moats Keep Competitors At Bay.)

Latest Results Prove It Works
Strong growth in its service-based billings and accelerating bookings for its JBoss application server product helped Red Hat report fiscal fourth quarter revenue of $142 million and pro forma EPS of 20 cents per share. These are up 27% and 28% respectively compared to the same period a year earlier. The results were also slightly ahead of consensus expectations for revenues and EPS of $141 million and 19 cents per share.

For fiscal 2009 management now projects revenue of $665-680 million, much better than prior consensus of $637 million, and up 27-30% from the previous year. However, this positive surprise on revenue was somewhat offset by lower-than-expected consensus EPS guidance of 78-82 cents per share compared with expectations of 85 cents. Higher development and marketing spending next year, designed to help the company gain long-term acceptance of its products in the corporate IT market, will hurt margins in the near term. (To learn how to analyze a company's performance, check out Advanced Financial Statement Analysis.)

Nevertheless, these results were well received by investors, who bid up the shares by 7% in after hours trading following the announcement.

Bottom Line
Red Hat could be the dark horse that manages to get through the pending downturn in recession-induced business spending on IT in relatively good shape. As Oracle's results have shown, big corporate clients are increasingly hesitant to pull the trigger on large IT purchases. With its clear upfront cost advantage, the open source business model championed by Red Hat could strike a positive chord with CIOs looking to do more with less in their corporate data centers.

For further reading on recessions and their impact, see Recession-Proof Your Portfolio and Recession: What Does It Mean To Investors?
By Eugene Bukoveczky



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