What's the Deal With Red Hat?
NEW YORK ( TheStreet) -- Software giant Red Hat (RHT) , a leader in open source technologies as well as cloud computing has now become one of these names that have placed me in the predicament of trying to justify its lofty valuation to potential investors. I'm not going to pretend that this a "rock and hard place" type of situation, but how do you rationalize taking a position in a stock sporting a P/E of 80 after it has already gained 50% on the year? It gets even more remarkable when you consider that a competitor such as VMware(VMW) , which by many standards already qualifies as expensive but trades at a multiple that is 14 points less
As well as Red Hat has performed in its most recent quarter, making a case to buy the stock is not as easy as it seems -- particularly when the word "valuation" comes at the forefront of the discussion. Having said that, I also appreciate that valuation concerns have rarely (if ever) mattered to tech companies. Because as noted, VMware sports a P/E of 66 while others within the space such as Salesforce.com (CRM) have sported P/Es that are off the charts -- literally. In trying to keep things in perspective, I am starting to warm up to the idea that perhaps for Red Hat, I might have been a tad too skeptical that it can grow into its valuation. What caused this sudden change was the improvement is showed in its Q4 results after having reported what I thought was a less than stellar Q3.
A much better Q4
The company recently reported impressive year-over-year growth rates in several key areas -- which include revenue, operating income, billings as well as operating cash flow, all of which topped not only last year's Q4 performances, but the full year as well. Gross profit arrived at $253.4 million -- representing an increase of 24.2% year over year from $204.2 million. Gross margin expanded 190 basis points to 85.3% in the quarter. The company said that these results were largely attributable to an increase in services gross margin as well as a better revenue mix.
It reported an increase of 20.6% in operating income which arrived at $53.6 million -- topping the $44.6 million that it reported in the prior-year quarter. This was indeed impressive; however operating margins arrived .2% lower than the prior quarter to 18.0%. But that slight decline was offset by an increase in net income that was reported at $37.6 million compared with $37.4 million in the prior-year quarter.