Wall Street Backs Red Hat

• Red Hat Inc RHT shares have been on an upturn through 2015, and have gained 20 percent year-to-date.
• Drexel Hamilton and Deutsche Bank analysts have Buy ratings on the company, while Pacific Crest maintained a Sector Weight rating.
• Red Hat reported large deals and exhibited solid execution, the analysts said, adding that this momentum could continue.

Red Hat closed 11 deals valued at more than $5 million and 3 deals exceeding $10 million in the FQ3 [November] quarter.

Red Hat reported sales of $523.6 million, representing 15 percent y/y growth and beating the Street estimate of $521.5 million. The company’s pro forma EPS came in at $0.48, exceeded the Street expectation of $0.46.

Red Hat raised its sales guidance from $2.034-$2.044 billion to $2.044-$2.048 billion. The company also projected 4Q sales of $535 million-$539 million and pro forma EPS of $0.47.

Riding The Open Source Wave

Drexel Hamilton’s Brian J. White raised the price target for Red Hat from $90 to $98. The analyst said that the company had “delivered another standout quarter with upside across key financial metrics.” Red Hat has also projected a strong F4Q.

Red Hat has successfully developed the paid Linux market, and has become an authority in the open source software arena. White believes that the company is poised for next-gen data center trends and the transition to the Cloud.

“Increasingly, we believe Red Hat is becoming a strategic partner for its partners and we expect this position to drive strong growth trends again in FY:17,” the analyst commented.

The revenue estimates for FY16 and FY17 have been raised from $531.9 million to $538 million and from $2.039 billion to $2.34 billion, respectively.

No Sign Of Slowing Momentum

Deutsche Bank’s Karl Keirstead raised the price target for Red Hat from $90 to $95. The company recorded 20 percent constant currency billings growth, beating the consensus estimates.

This performance was delivered while “almost every other large infrastructure technology vendor is struggling with a weak demand backdrop and/or cloud-related pressure in their on-premise business,” Keirstead pointed out.

Red Hat continued to gain share, with a large portion of new apps being Linux-based and since enterprise re-platforming often boosts the consumption of RHEL [Red Hat Enterprise Linux]. “Given 19% c/c billings growth, 21% revs growth and 19% FCF growth over the last 3 qtrs, we view the FCF multiple as compelling, especially given RHT’s cloud exposure,” the analyst wrote.

Requires Clear Signs Of Sustainability

Pacific Crest’s Ben McFadden said that Red Hat’s performance exceeded expectations across revenue, billings, EPS and FCF.

“Cross-selling continues to drive large deals… existing customers are increasingly buying more solutions to complement core Red Hat Enterprise Linux,” McFadden wrote.

While Red Hat has diversified its revenue stream with OpenStack, storage, virtualization and cloud management solutions, these represent only a small portion of total revenue.

“While FQ3 results were solid, the business remains heavily tied to on-premise deployments and OpenStack traction remains nascent, which we believe creates risk of the story showing near-term deceleration. CCP traction is promising, but is also likely to shorten the duration of bookings,” the Pacific Crest report noted.

McFadden recommended waiting for either a pullback or clear signs of sustainability of the robust momentum on the on-premise business into F2017.