When a company's 39-year-old CFO quits just days before quarterly earnings to pursue new opportunities, it's a clue to invest your money elsewhere. When the same company's stock is priced beyond perfection, that's proof it's time to sell.
Red Hat (Nasdaq: RHAT ) CFO Kevin Thompson's resignation is certainly timely. Stock in the open-source technology provider has more than tripled in the past year. After topping out above $29.00 at the beginning of June, the stock has started to slide.
Red Hat is the stock market's favorite play on Linux, selling more of the technology than anyone else in the market. But things are going to get harder for Red Hat management -- not to mention the shareholders.
For starters, Novell (Nasdaq: NOVL ) , having purchased Red Hat's major rivals, Ximian and SUSE, could emerge as a big Linux market competitor thanks to Novell's much larger server software sales and support force. Novell could set back Red Hat's growth path. Besides, the easy pickings are gone for Red Hat. According to the research firm Gartner Group, more than 15% of servers are already shipped with Linux software.
Prospects for the Linux market are clouded by Unix software maker SCO Group's (Nasdaq: SCOX ) aggressive litigation. SCO claims current versions of Linux from Red Hat, Novell and IBM (NYSE: IBM ) infringe on its intellectual property. It wants $5 billion in compensation. The threat of lawsuits has a lot of big Linux customers very worried.
Even worse, at $24.00, Red Hat trades at a whopping 110 times 2004 earnings, or 22 times expected fiscal revenue for 2005. With a market cap of $4.5 billion, Red Hat's valuation outstrips the entire $1 billion market forecast for Linux. Even if Red Hat's first-quarter figures (out on Thursday) blow the socks off analysts' estimates, they still won't be able to provide a convincing case for that valuation level.
At such a lofty price, Red Hat stock remains vulnerable to even the smallest misstep. Is it any surprise the CFO has decided to call it quits?
Fool contributor Ben McClure does not own shares of any of the companies mentioned.