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Red Hat (NYSE: RHT ) just knocked the cover off another quarterly report, and the market is sitting up to take notice.
In the second quarter of fiscal 2011, the inveterate Linux vendor reported 20% stronger sales year over year and roughly flat earnings; improving business conditions led management to raise guidance significantly. The stock reacted strongly to the news and is one of the biggest gainers on the market today. In fact, Red Hat is trading at 10-year highs now and looks set to run even higher.
If you bought Red Hat when I told you to act on a temporary dip six months ago, you're sitting on a 40% gain today. Over the same time period, that beats even fellow high-tech highfliers like Informatica (Nasdaq: INFA ) , Apple (Nasdaq: AAPL ) , or nearly any other market darling. Not bad for a company that makes a living selling software you can get for free.
But wait -- there's more!
That's the tale of the tape, but the real story is that Mr. Market is starting to take notice of Red Hat's unique business model. I'd love to say that investors and analysts understand it, but that watershed moment still seems to elude most of them.
In an exclusive interview after the traditional earning call, CEO Jim Whitehurst took the time to talk with me about what makes Red Hat a success in open-source software sales, where everybody from Novell (Nasdaq: NOVL ) to Oracle (Nasdaq: ORCL ) has largely failed.
"We're not selling software, right? The software is free," Whitehurst said. "We have to add value around the software, beyond the software. The point is, are your applications certified? Is EMC (NYSE: EMC ) certified to work with that? All of that work goes into taking the open-source development model and making that into an enterprise-class, stable ecosystem that's just gonna work."
Whitehurst continued: "We recognize that we don't sell functionality because that's free. We're adding value around that. That's important, and I think that's missed by a lot of people."
Tipping the cap to co-opetition
In the same vein, Whitehurst doesn't necessarily see other Linux distributors as competition, whether it's paid packages such as Novell's SuSE, free ones like the Debian and Ubuntu projects, or direct Red Hat rip-offs in the Oracle Unbreakable Linux mold. All of these supposed competitors contribute code to the Linux solution and are just looking for various ways to profit from doing so. "We're more like brothers in arms, expanding the Linux market," Whitehurst said.
Red Hat's own Fedora project is essentially a part of the company's research department, drawing on a global network of paid and unpaid developers to hammer out what often becomes the next version of RHEL. It doesn't matter whether the code comes from Fedora or Debian, from Novell or frequent Linux contributor IBM (NYSE: IBM ) . The point is to have the industry connections and the support system to create a platform that's ready for all kinds of business use. If you build that, the customers will come. Red Hat has them in spades.
For example, Ubuntu is doing a great job of making Linux usable as a desktop operating system while Red Hat has no interest in that market and prefers to dominate the datacenter. As for the red-hot mobile platform market, the company would love to find a way into that trend, but is not spending significant time, money, or resources on exploring it. You can just grab an Android handset if you want Linux on your phone, after all. Enterprise computing offers plenty of green fields to explore, and Red Hat is happy there.
What you can do now
Red Hat has quietly become a powerhouse behind the scenes in cloud computing and virtualization, and you'll often find its products running your favorite Web services or databases. Linux is now a reliable and respectable choice for serious, supportable business use. Red Hat played a large part in making that happen, and now stands to reap serious rewards from remaining at the avant garde of this movement.
The stock has crushed the market in recent months, but you ain't seen nothin' yet. As Whitehurst noted, most investors still don't get what's going on here and that makes for a fine investment thesis. If you're not ready to commit real money to this unmatched and nearly unimaginable business model, you can do what I did and make an "outperform" call in our CAPS system. With market beaters like Red Hat, you'll be an All-Star CAPS player in no time.