Open-source software leader Red Hat (NASDAQ:RHAT) reports earnings after the bell today, and analysts are expecting a doozy. With on-again-off-again reports that Oracle (NASDAQ:ORCL) may enter the Linux market, Red Hat's stock has certainly been volatile, but management has been quite sanguine about further competition from the database giant. Is this one huge strategic misstep or savvy thinking? Read on for my thoughts.

What analysts say:

  • Buy, sell, or waffle? Twenty analysts cover Red Hat. The stock gets 14 buy ratings, four holds, and two sells.
  • Revenues. On average, sales are expected to rise 48% year over year to $97.1 million.
  • Earnings. And earnings are expected to spike 22% year over year to $0.11 cents a share.

What management says:
Marc Fleury, former founder of JBoss, and now a vice president at Red Hat after that company acquired his, doesn't believe that Oracle will enter the Linux market. In a lengthy blog post, he notes that not only do the two companies work together already on a variety of projects, but few existing Oracle customers, according to a study, would even be interested in Oracle's version of Linux. Most interestingly, Fleury comments that "I believe we are seeing a Nash Equilibrium in action. If there is a set of strategies with the property that no player can benefit by changing his or her strategy while the other players keep their strategies unchanged, then that set of strategies and the corresponding payoffs constitute the Nash Equilibrium. A simple way to describe this is the popular saying 'nobody move and nobody gets hurt.' "

What management does:
Margins continued to be strong, although last quarter they suffered a bit due to stock option costs and a higher-than-expected GAAP tax rate at 37%. Keep in mind, though, that Red Hat's cash tax rate is still expected to be 5% for some time to come due to prior accumulated losses. However, don't be surprised if tomorrow we see a slightly lower trend, as the JBoss acquisition is supposed to drop margins about 75 basis points.

Margins %

2/05

5/05

8/05

11/05

2/06

5/06

Gross

80.4

80.2

80.6

81.6

82.6

83.8

Op.

13.7

13.5

15.2

18.3

20.9

23.0

Net

23.1

21.8

22.1

25

28.6

26.9
*All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ending in the named months.

One Fool says:
While Marc Fleury raises a challenging viewpoint in response to many investor queries, I think he is underestimating Larry Ellison's, shall we say, insanity quotient. Certainly, the PeopleSoft and Siebel mergers qualified as unconventional at the time, and despite numerous challenges, they seem to have worked out well so far. Also, the numerous departures of top management from Oracle in recent years due to clashes with its famous CEO help to demonstrate Ellison's ability to be, well, irrational. You see, there can only be a Nash Equilibrium if all players act rationally, and Larry has never been one to do the expected. I'm willing to bet his desire to win at all costs, and the relative attractiveness of Red Hat's software niche, may eventually result in a suboptimal solution for Red Hat, even if that ends up hurting Oracle in the short term as well.

Related companies:

  • Microsoft (NASDAQ:MSFT)
  • VA Linux (NASDAQ:LNUX)
  • SCO Group (NASDAQ:SCOX)
  • VMWare (via EMC) (NYSE:EMC)

Related Foolishness:

Want more Foolishness in your life? Try any of our newsletters free for 30 days.

Fool contributorStephen Ellis doesn't hold shares in any companies mentioned. You can see his holdings foryourself. The Motley Fool has an open-minded disclosure policy.