Linux vendor Red Hat (NYSE:RHT) had a strange week. The company reported second-quarter results last Thursday, beating analyst targets and raising full-year guidance on both the top and bottom lines. Red Hat also announced the $81.5 million acquisition of mobile back-end platform specialist FeedHenry, giving Red Hat a brand new angle of attack on the mobile computing market.
... And Red Hat shares tanked on the news. The next day, shares fell as much as 8% on heavy volume.
Red Hat's adjusted earnings rose 17% year over year, landing at $0.41 per diluted share. Sales jumped 19% higher, stopping at $446 million. Analysts would have settled for earnings of $0.38 per share on roughly $435 million in revenue.
In an exclusive call to the Fool, Red Hat CEO Jim Whitehurst pondered the reasons behind this upside-down market reaction.
"We raised our revenue guidance for the full year, but maybe we didn't raise it fast enough," he said. "The whisper numbers may have been a little bit higher."
Adding to that theory, I'll note that Red Hat's stock approached this report on a full head of steam. Over the previous three months, Red Hat shares had delivered a 14.2% return while the S&P 500 (SNPINDEX:^GSPC) only managed to gain 2.8%. Under these circumstances, the pressure to deliver shocking growth increases and a mere "surprise" might not have been good enough.
With Whitehurst on the horn, I took the opportunity to follow up on three long-term themes. These are evergreen topics that always seem to hover in front of Red Hat, and here are the latest updates:
Red Hat's balance sheet has been debt-free since 2009, and its cash reserves rarely dip below $500 million. Meanwhile, Red Hat's free cash flows keep on growing:
Normally, I'd ask Whitehurst if he's looking to invest some of this capital in game-changing acquisitions -- but the company has actually already announced three such deals in 2014.
So let's try a new angle. With interest rates and bond yields running historically low, why isn't Red Hat tapping into this low-cost debt supply while it's still cheap? After all, Red Hat would hardly be the first tech company to go this route, and the low rates can't last forever.
Whitehurst assured me that Red Hat is in no need of emergency cash and prefers to fund its buyouts from cash flows. That said, he wouldn't completely rule out a look at the debt markets.
"The rates are low right now," he said, "and we're always looking at the best ways to manage our cash."
But, don't hold your breath waiting for a Red Hat bond offering.
Here's something that Whitehurst actually has ruled out on several occasions. In his view, Red Hat is perfectly happy on the server side of the mobile market, leaving the handset software battlefield for others to fight over. That hasn't changed, even if FeedHenry plugs into the mobile app development market.
"Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG)(NASDAQ:GOOGL) own the mobile platform market, and Microsoft (NASDAQ:MSFT) is ... in there somewhere," he said. "There's no need to bring Red Hat into the mix, because those guys are already doing a great job and owning the market."
That being said, the server-side market is still open for fresh expansion. And that brings us right to the third talking point.
Red Hat OpenStack
Red Hat plays many roles in this arena already, thanks to the widespread use of Red Hat Enterprise Linux and the OpenStack cloud platform.
In fact, OpenStack sales helped Red Hat fly past analyst revenue targets and its own guidance in the second quarter, as over 80 public cloud providers resell Red Hat's software today. Red Hat Enterprise Linux sales, which are tied to subscription-style licenses and recognized as revenue over several quarters, provide a slow-and-steady growth platform. But the cloud-based sales move into revenues right away, giving Red Hat a quicker sales boost.
"We don't prefer one of these sales models over the other," Whitehurst told me. "Cloud sales are not larger or smaller, and the margins are about the same. They're just different in terms of how quickly we collect the cash and recognize the revenue."
FeedHenry, then, doesn't exactly change Red Hat's stance on mobile computing. Instead, it's a plug-in acquisition that bolsters an already thriving back-end business.
In the end, this quarter wasn't much different from Red Hat's recent history. The company has exceeded earnings estimates in each of the past seven quarters, driven by robust demand for open-source solutions. The business model is changing a little bit, as subscription sales now represent the majority of Red Hat's revenues.
But the fundamental business idea is still the same, and Whitehurst has no plans to make any drastic changes. Red Hat and other next-generation software vendors are changing the way IT enterprises do business, and reaping the rewards on behalf of shareholders along the way.
As a Red Hat shareholder myself, I'm perfectly fine with all of that.
Anders Bylund owns shares of Google (A shares) and Red Hat. The Motley Fool recommends Apple and Google (A and C shares) and owns shares of Apple, Google (A and C shares), and Microsoft. Try any of our Foolish newsletter services free for 30 days.
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