Red Hat, Inc. RHT S
March 31, 2009 - 2:14pm EST by
heffer504
2009 2010
Price: 18.30 EPS $0.38 $0.37
Shares Out. (in M): 195 P/E 48.0x 50.0x
Market Cap (in $M): 3,570 P/FCF n/a n/a
Net Debt (in $M): -850 EBIT 105 125
TEV ($): 2,720 TEV/EBIT 26.0x 22.0x
Borrow Cost: NA

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Description

 

Red Hat is a company that provides service for open-source software.  It has benefited from a focus by enterprises on reducing their software spend, and has reported impressive retention statistics.  However, the valuation is fairly egregious, the stock has run-up based on recent inclusion in the IBD 100 and end-of-quarter portfolio window dressing, and some aggressive accounting.  In addition, most sell-side price targets are below the current share price.

 

Here are some of the red flags, as I see them:

1) Declining billings growth:

1q08

28%

2q08

24%

3q08

30%

4q08

34%

1q09

23%

2q09

29%

3q09

13%

4q09

11%

2010e

9%

 

2) Reported GAAP EBIT is basically flat for several years:

 

  gaap 
  ebit
4q09           20.2
3q09           21.0
2q09           21.4
1q09           19.9
4q08           18.2
3q08           19.5
2q08           17.8
1q08           15.0
4q07           16.6
3q07           13.6
2q07             9.5
1q07           12.6
4q06           19.8

 

3) "Non-GAAP" EBIT excludes stock compensation and amortization (2 quarters ago, only excluded stock compensation), and stock comp has been increasing-guidance is for 13m a quarter for f10

4q09

14.6

3q09

12.2

2q09

10.9

1q09

10.6

4q08

9.5

3q08

9.5

2q08

8.6

1q08

8.4

4q07

8.5

3q07

8.3

 

4)  Prepaid expenses have increased dramatically.  While this also includes a deferred tax asset amount, the company has not explained this adequately.

 

fiscal prepaid def revs revs ppd/revs ppd/def
4q09           99.4         382.1         166.2 60% 26%
3q09           78.1         352.7         165.3 47% 22%
2q09           69.2         346.9         164.4 42% 20%
1q09           85.7         351.2         156.6 55% 24%
4q08           75.2         339.1         141.5 53% 22%
3q08           74.1         301.7         135.4 55% 25%
2q08           57.9         278.4         127.3 45% 21%
1q08           53.3         264.7         118.9 45% 20%
4q07           41.0         249.6         111.1 37% 16%
3q07           34.1         227.8         105.8 32% 15%
2q07           27.9         211.4           99.7 28% 13%
1q07           18.3         183.5           84.0 22% 10%
4q06           16.5         162.9           78.9 21% 10%

 

5) Valuation is aggressive

Red Hat will be paying full taxes over the next year.  Ignoring amortization but including stock comp as a true expense, company guidance is for ~$125m of EBITA in f2010.  This means the stock trades, net of cash, at 36x taxed EBIT.  This seems too high for a company that sells service on a free product (and thus can be replaced fairly easily over time) and is growing under 10% with flat GAAP EBITA for the last few years.  There is currency risk, and the benefit to reported EPS from buying in their convertible note (and thus reducing share count) will only help for one more quarter.

 

6) Downgrades are coming

 

Firm Name Analyst Recommendation Tgt Px
BAS-ML RANGAN buy $18.00
Deutsche Bank RAKER hold $17.00
RBC Capital Markets BREZA sector perform $18.00
UBS BELLINI neutral $16.00
JPMorgan DIFUCCI neutral $16.00
Jefferies EGBERT buy $18.00
Pacific Crest Securities ELSHESHAI outperform $19.00
Robert W. Baird & Co ASHLEY outperform $17.00
Citi THILL hold $17.00
Raymond James TURITS market perform  
Cantor Fitzgerald BAYER hold $16.00
Stifel Nicolaus WELLER hold  
Oppenheimer & Co DENYEAU market perform  
Cross Research WILLIAMS hold $14.00
Piper Jaffray MURPHY buy $22.00
Goldman Sachs FRIAR neutral/neutral $15.00
Thomas Weisel Partners KLASELL market weight $17.00
Matrix/Lighthouse TEAM COVERAGE sell  
Argus Research Corp CALABRESE hold  
The Benchmark Company LLC WILLIAMS buy $17.00
Morgan Stanley HOLT Equalwt/Attractive
Barclays Capital HERNANDEZ equalwt/positive $18.00

Catalyst

downgrades

end of momentum buying/ window dressing

accounting issues

billing slow-down

 

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