Let's Lift the Red Hat and Look Inside

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Red Hat (NYSE: RHT  ) keeps more money under its jaunty fedora than you'd think.

I'm not talking about the Linux veteran's cash balance, though that is certainly robust at $968 million with about $60 million of operating cash flow per quarter. No, the sneaky sales strength of Red Hat comes from a habit of landing long-term contracts with only small payments due at signing. In the just-reported first quarter of fiscal 2011, Red Hat sealed the largest deal in the company's history, but only 5% of the "eight-figure deal" fell to the top line right away and most of the balance remains an undisclosed sum waiting to hit the financial statements in coming quarters.

The numbers we did get to see weren't too shabby, either. Revenue increased by 20% year over year to $209 million, and a whopping $179 million of that business came from subscription fees. And like I said, Red Hat has a lot of guaranteed business in its internal books that won't show up anywhere in the income statement until those customers start paying their subscription bills.

It's a slow trickle of extremely steady sales that reminds me of how Intuitive Surgical collects tons of revenue from disposable attachments to its surgical robots, or how Green Mountain Coffee Roasters is getting rich on single-serving bean pads for those Keurig brewing machines. Unlike those proven winners, Red Hat has a reserve of already-signed contracts that remain hidden to us outsiders. It's a beautiful thing.

And the fact that Red Hat keeps signing new customers while renewing old contracts at significant premiums to the expired deals shows me that the product is worthwhile, the business model works, and the train will keep on rolling. Microsoft (Nasdaq: MSFT  ) no longer seems to spend much effort to battle Red Hat and other Linux vendors head-to-head; Novell (Nasdaq: NOVL  ) wants someone to buy the whole operation, which undermines the SuSE Linux platform somewhat; and the community-supported Ubuntu Linux bundle doesn't have the enterprise-class support system that is Red Hat's pride and joy. Red Hat's moat is broader than it seems at a cursory glance.

That's why I just rated Red Hat "outperform" for the next five years in our Motley Fool CAPS system. If you have a sense of where Red Hat is going -- up or down -- you can follow my footsteps in a couple of easy clicks. Your CAPS score will thank me later.

Fool contributor Anders Bylund owns shares in Intuitive Surgical, but he holds no other position in any of the companies discussed here. Microsoft is a Motley Fool Inside Value pick. Green Mountain Coffee Roasters and Intuitive Surgical are Motley Fool Rule Breakers recommendations. Motley Fool Options has recommended a diagonal call position on Microsoft. Try any of our Foolish newsletters today, free for 30 days.You can check out Anders' holdings and a concise bio if you like, and The Motley Fool is investors writing for investors.

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  • Report this Comment On June 24, 2010, at 9:49 AM, zoopster wrote:

    I guess you missed the fact that Ubuntu is "commercially sponsored" by Canonical and has a fast growing support organization behind it.

    While Red Hat has taken a while to get somewhere, Ubuntu on the other hand has only been in existence for just over 5 years and is the leader in desktop Linux with the server coming up fast and by some accounts has already overtaken SuSE in the enterprise server market.

    Don't rule out Ubuntu.

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