Earnings Preview: Red Hat

Red Hat Inc. (RHT - Snapshot Report) is set to release its first quarter 2013 results after the closing bell on June 20, 2012. In the run up to the earnings results, we did not notice any substantial movement in analysts’ estimates.

Prior Quarter Highlights

Red Hat reported a mixed fourth quarter, where the bottom line missed the Zacks Consensus Estimate while the top line surpassed. The strong year-over-year growth in the top line was driven by higher demand for Red Hat technologies and efficient sales execution in addition to upselling and cross selling of Red Hat products and services.

For the first quarter of 2013, Red Hat expects revenues to be in the range of $307.0 million to $311.0 million. Non-GAAP EPS is projected to be in the range of 25 cents to 27 cents. Management expects the non-GAAP operating margin to be in the range of 24.0% to 24.2%.

For further details please see: Red Hat Reports Mixed 4Q

Estimation Revision Trend

Over the past 30 days, none of the 11 analysts covering the stock revised their estimates for the quarter. Thus, the Zacks Consensus Estimate for the first quarter was pinned at 19 cents per share.

Red Hat has matched or exceeded the Zacks Consensus Estimate in the four preceding quarters. The average surprise in these quarters is a positive 12.94%, and for the current quarter we expect the company to beat the Zacks Consensus by the same magnitude.

Analysts expect Red Hat to exceed the consensus estimates on the back of continued demand for servers. Moreover, strong demand for RHEL 6 and JBoss is expected to drive the top line for the quarter. Additionally, the company’s offerings in the cloud computing market, ongoing server virtualizations and traction in the middleware section are expected to be incrementally beneficial in the long run.

However, volatility in foreign currencies, especially the Euro, and an unstable macro-economic environment are the potential headwinds in the near term.

Recommendation

We believe that Red Hat is emerging as a significant player in the cloud computing arena over the long term. Red Hat boasts an impressive product line up and expects to invest heavily on the development of innovative products. Its significant partnerships with large public cloud customers such as Amazon Web Services, International Business Machines Corp. (IBM - Analyst Report), NTT and Swisscom are also expected to boost its top-line growth going forward.

While we believe this is the way to go considering the growth prospects in the market and growing competition, we note that the company needs to spend prudently, since its significant costs are likely to put pressure on the bottom line.

At the same time, we don’t expect competitive pressures to alleviate given the deep pockets of rivals such as Microsoft Corp. (MSFT - Analyst Report), VMware Inc. (VMW - Snapshot Report) and Oracle Corp. (ORCL - Analyst Report).

We maintain our Neutral recommendation over the long term (6-12 months). Currently, Red Hat has a Zacks #4 Rank, which implies a ‘Sell’ rating in the short term.