St. Patrick's Day has come and gone, and with it, the fashionable green ties. Tomorrow, red will be the order of the day. Red Hat
Wall Street Wisdom:
- General consensus. Eighteen analysts follow Red Hat, with 11 of them rating the stock a buy, one a sell, and six a hold.
- Revenues. Analysts are looking for 36% revenue growth over fiscal Q4 2005, to $78.3 million.
- Earnings. Meanwhile, profits are expected to double year over year, to $0.12 per share. What's more, Red Hat has beaten consensus estimates in three of the last four quarters.
Margin watch:
Here's something you don't see very often. Red Hat's rolling gross margin has risen 390 basis points over the past 18 months, but its operating and gross margins are up even more. Red Hat today is 66% more profitable than it was a year and a half ago on an operating basis, and 24% more profitable on a net basis. Further evidence of why investors love software companies: Once they achieve critical mass, incremental sales become as close to pure profit as you can get.
|
Margins % |
8/04 |
11/04 |
2/05 |
5/05 |
8/05 |
11/05 |
|---|---|---|---|---|---|---|
|
Gross |
77.9 |
79.4 |
80.7 |
80.7 |
80.9 |
81.8 |
|
Op. |
11.9 |
13.9 |
16.2 |
15.8 |
16.9 |
19.7 |
|
Net |
20.2 |
21.8 |
23.1 |
21.8 |
22.1 |
25 |
Foolish forensics:
The most unusual item in the above is the fact that net margins significantly exceed operating margins. Ordinarily, this happens when a company records an unusual item, such as a tax credit, that artificially boosts profitability. But in Red Hat's case, unusual items increased pre-tax income by only about 7% over the past year. Non-operating profits made up significantly more -- 35% -- and so those are the ones we should look at to determine why Red Hat's net margin is so much higher than its operating margin.
If we turn to the company's most recent 10-Q filing, a quick word search for "other income" reveals that Red Hat has been buying back debt at less than face value -- and every time it does so, it records the difference as profit. In the first half of fiscal 2006, Red Hat bought back $30 million worth of debt for $26.3 million -- a 12% discount. With $570 million worth of debentures still outstanding at last report, I expect Red Hat can keep on doing this for quite some time. Expect the discount to contract, however, as its balance sheet gets stronger.
Also note that, because these debentures are convertible into stock, every time Red Hat buys some back, its diluted share count should fall. It has, in fact, declined 2% over the past year.
Competitors:
Red Hat's competitors in the computer operating systems market include granddaddy Microsoft
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Fool contributorRich Smithhas no interest, short or long, in any company named above.
