Why You Should Be Buying this Enterprise Software Company

Shweta is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Red Hat’s (NYSE: RHT) stock is trading between $50 to $60 since April. Its current share price is down around 8% in one month. But when we take into consideration its 2Q 2012 revenue growth and compare it with its enterprise software peers, Red Hat's fundamentals still score above competition. Let’s analyze how this company is placed against its peers. The following chart summarizes the 2Q 2012 revenue growth and gross margins in the last 12 months for Red Hat, Microsoft and Oracle.

<table> <tbody> <tr> <td> <p>Company</p> </td> <td> <p>Qtrly Rev Growth (yoy)</p> </td> <td> <p>Gross Margin</p> </td> </tr> <tr> <td> <p>Red Hat</p> </td> <td> <p>15%</p> </td> <td> <p>85%</p> </td> </tr> <tr> <td> <p><strong>Microsoft </strong><span class="ticker" data-id="204577">(NASDAQ: <a href="http://caps.fool.com/Ticker/MSFT.aspx">MSFT</a>)</span><strong> </strong><strong></strong></p> </td> <td> <p>-8%</p> </td> <td> <p>75%</p> </td> </tr> <tr> <td> <p><strong>Oracle </strong><span class="ticker" data-id="204823">(NYSE: <a href="http://caps.fool.com/Ticker/ORCL.aspx">ORCL</a>)</span><strong></strong></p> </td> <td> <p>-2%</p> </td> <td> <p>79%</p> </td> </tr> </tbody> </table>

Source: Yahoo Finance

We can clearly see that Red Hat scores better than its peers when it comes to growth and profitability. Microsoft & Oracle stand at -8% & -2% growth, respectively, while Red Hat has seen growth of 15% for the same period. Going forward, I can see Red Hat as an impressive stock given its long term growth potential in Middleware and Storage businesses, which have proven to be quite valuable in the 2Q 2012 earnings report.

Determinants of Future Development:

Middleware Growth

Beating the growth in the company’s core business in 2Q 2012, its Middleware Business has now become the top priority for the company. In order to augment its Middleware offerings Red Hat acquired technologies from FusionSource and Polymita, which will position the company well compared to its competitors (IBM’s WebSphere and Oracle’s WebLogic), will strengthen its JBoss Enterprise Middleware Software Integration. The deal will merge products such as Fuse ESB Enterprise, Fuse MQ Enterprise, and Polymita's BPM to the JBoss middleware product family. The company is targeting to double or triple its middleware business with these core products. As another part of this deal, the company plans to integrate Fuse technology into Red Hat's products, such as the JBoss Enterprise Application Platform & JBoss SOA Platform within the next six to nine months.

Moreover, Red Hat recently launched Integration Capabilities with SAP® Solutions, which aims to give programmers a better & simpler way to develop modern applications.The company is working to provide capabilities that make it easier to consume SAP application data and business processes from Red Hat's JBoss Enterprise SOA Platform, the JBoss Enterprise Data Services Platform, or the JBoss Enterprise Application Platform. The Company has successfully grown the JBoss customer base from 1,000 to more than 10,000 since its acquisition in 2006, and I see Red Hat leveraging this in the future to drive larger JBoss deals.

Storage and Cloud Computing

Besides its Middleware Business, Red Hat is now also looking for new revenue streams such as ‘Storage,’ which provides a strong opportunity to expand the market over time. For that purpose, it acquired Gluster on Oct. 11 & renamed it Red Hat Storage, re-purposing the company to serve as a software based alternative to hard drive storage. With its re-launching scheduled in 3Q 2013, the product will provide an economic way of storing large data. The existing Gluster product line goes well with the Red Hat core competencies & the company is planning to incorporate Gluster products into other Red Hat solutions and offer them using a typical subscription model. With an estimated growth of 40x in storage data by 2020, I can see the company's storage end having larger revenue opportunity ahead.

Under its cloud computing segment, Red Hat has the monopoly in offering an open source for PaaS & open hybrid cloud, which can be seen as an important tool to maintain its market leadership. The strong growth of 30% expected in PaaS through 2016, makes Red Hat an increasingly attractive option for enterprises and service providers.

Also, the support of OpenStack is troublesome to other cloud infrastructure players including Microsoft and VMware.

Red Hat Enterprise Linux (RHEL)

Another area of Red Hat's supremacy is RHEL, which is a highly endorsed O/S for private cloud deployments, with large customers including DreamWorks and the U.S. Department of the Interior. RHEL is also benefiting from the explosive growth in SaaS and online services, including at Salesforce.com & Amazon. The new pricing model introduced in 2010, along with the release of RHEL 6, showed incremental revenue in 2011, which is expected to continue in 2012. Under the model the customers have to pay a higher price when they virtualize multiple applications on a single instance of RHEL.

I think RHEL remains the money maker for the company, along with the upcoming RHEV 3.1 (Red Hat Enterprise Virtualization), which further adds to the value. The consulting services revenue on the other side is expected to see an upside when RHEL7 certification comes out next year

To conclude, I can see upside potential for RedHat, as it is gaining market share in high end computing and its RHELis replacing Windows server with public clouds. Also, with the growing mix of deals in IT & cloud computing, besides its core services (government and financial) and the gaining momentum in newer product growth opportunities, (e.g., virtualization, storage, PaaS), it is bound to be a major mover in FY 2013.

ShwetaDubey has no positions in the stocks mentioned above. The Motley Fool owns shares of Microsoft and Oracle. Motley Fool newsletter services recommend Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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