Will Red Hat, Inc. Profit From its Investment in This Burgeoning Market?

Red Hat has been investing heavily in open cloud infrastructure technologies, including an acquisition in the first quarter. Will this pay off for the company down the line?

Jul 7, 2014 at 2:00PM

Open-source provider Red Hat (NYSE:RHT) reported results for its first quarter in June. The company is doing well, including revenue of $424 million, $9 million above the high end of its own guidance, and a 17% increase, year over year. However, the big news within Red Hat is the continuing investment in OpenStack, an open-source cloud infrastructure that allows companies to build their own version of a cloud like Amazon.com's AWS or Microsoft's Azure. What has Red Hat been doing on the cloud infrastructure front, and will it pay off for the company down the line?

In June, Red Hat announced its intention to acquire OpenStack expert eNovance, which provides cloud infrastructure services for enterprises and service providers. Red Hat will pay approximately 50 million euros in cash and 20 million euros in Red Hat shares for eNovance, and the deal is expected to close in the coming weeks.

Red Hat is in the early stages of engagement on OpenStack with many enterprise customers. However, management has stated that a lack of qualified OpenStack professionals has been holding back the number of proof-of-concept projects that Red Hat has been able to initiate with customers. With its acquisition of eNovance, Red Hat will get a 110 person team, 60-70 of whom have consulting skills to help Red Hat scale out its OpenStack business.

Profit or loss
Over the last year, thanks to increased R&D and sales costs related to OpenStack, operating expenses have outpaced revenue at Red Hat. As a result, EPS is down by $0.01 year over year in the first quarter. When asked about this trend on the earnings conference call, management effectively said they would be crazy not to step up investment given the size of the opportunity.

RHT Total Operating Expenses (Quarterly) Chart

Red Hat Revenue vs. Operating Expense Growth. Source: Red Hat. 

Red Hat has previously warned that revenue from its cloud initiatives will remain light in 2014. In the first quarter, Red Hat's emerging technology products, which also include its middleware offerings, accounted for only 13% of the company's revenue. It might take a year or more for customers to start buying regular subscriptions for Red Hat's flavor of OpenStack, but until then, the smaller proof-of-concept projects will contribute to training and services revenue. It's worth keeping an eye on these numbers, because an increase in services might indicate more significant growth down the line. 

How big is this opportunity?
Red Hat CEO Jim Whitehurst has stated that he has seen more interest in OpenStack than in any other Red Hat product since Linux, which contributed $315 million in subscription revenue to the company in the first quarter. Gartner expects that by 2017, nearly half of large enterprises will deploy a combination of a private and a public cloud, known as a hybrid cloud. The security concerns following the NSA leaks have driven a lot of interest in this approach, and consequently in OpenStack, which is the major open-source, non-proprietary way for enterprises to build their own private cloud.

A sign of the interest in OpenStack is that even a nominal competitor such as VMware (NYSE:VMW) is getting involved. VMware sells its own proprietary cloud infrastructure, and at the time that it joined the OpenStack Foundation, existing members raised concerns that VMware is looking to subdue OpenStack from the inside. However, given VMware's serious level of contribution to the OpenStack project since that time, it seems that a more likely reason is that the virtualization giant sees the potential in OpenStack and doesn't want to be left out as OpenStack continues to grow and spread.

In conclusion
Red Hat's revenue grew an impressive 17% in the first quarter, compared to last year. However, operating costs increased at an even greater pace, due to the company's continued investment in the open-source cloud infrastructure OpenStack. Management believes this opportunity is too good to pass up, and judging by the level of industrywide interest, they are probably right.

Warren Buffett: This new technology is a "real threat"
At the recent Berkshire Hathaway annual meeting, Warren Buffett admitted this emerging technology is threatening his biggest cash-cow. While Buffett shakes in his billionaire-boots, only a few investors are embracing this new market which experts say will be worth over $2 trillion. Find out how you can cash in on this technology before the crowd catches on, by jumping onto one company that could get you the biggest piece of the action. Click here to access a FREE investor alert on the company we're calling the "brains behind" the technology.


Srdjan Bejakovic has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and VMware. The Motley Fool owns shares of Amazon.com, Microsoft, and VMware. 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.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information