Red Hat has been taking a beating in the stock market recently, but in a recent research note leading analyst Mark Murphy of Piper Jaffray thinks this represents an exceptional opportunity to buy into a "deeply undervalued" company. More interestingly, Murphy finds significant cause for Red Hat optimism based on Oracle's failed attempt to undermine Red Hat with its Unbreakable Linux product.
If Red Hat's model were fragile, the thinking goes, surely a behemoth like Oracle could make a dent in Red Hat revenues? Oracle got into the Linux game two years ago, hoping to cannibalize Red Hat's business for itself.
As Murphy points out, however, Oracle has completely failed to hurt Red Hat, calling into question the belief that Red Hat's demise is just a fork away. Novell, too, despite starting to build a decent Linux business of its own, as The VAR Guy has noted, has completely failed to touch Red Hat's rising revenue. The reason? Red Hat remains the default choice for enterprises looking to move off expensive Unix to high-performance and low-cost Linux.
Oracle has failed in its attempt to enter the Linux market. Our recent survey of Oracle database customers reveals that only 1 out of 32 customers currently uses Oracle Unbreakable Linux. This one customer also commented that "support is terrible, it is difficult to get an answer to my problems, Oracle's agents never understand my company." The survey reflects a very low penetration rate in the 2-year period since Oracle unveiled Unbreakable Linux with much fanfare, including live penguins running around onstage with Larry Ellison. Resellers continue to characterize Unbreakable Linuxas a failure because Oracle ultimately cannot control the future direction of RedHat Enterprise Linux, upon which it is based.
While the Street has expected Unbreakable Linux to severely impact Red Hat, its failure ironically serves as a proof-point of the underlying defensibility of RedHat's business model. In fact, in the two years since Oracle introduced Unbreakable Linux, Red Hat's billings have grown at an average rate of 31%--representing clear market share gains.
When Red Hat's biggest rivals can't hurt it, surely this is cause for optimism, and not a market slide? It turns out that being the "source of code" is a great alternative to owning the source code, at least in Red Hat's case.
Red Hat has shown no signs of slowing, with its subscription model able to weather the current recession: even if it doesn't sell any new subscriptions, it can tread water and/or grow with its existing customer base, something that license-revenue driven companies simply can't afford to do.
Murphy ends his analysis by suggesting that "the underlying value proposition of [Red Hat's] open source offerings, its superior brand recognition, large referenceable customer base, the reinforcing "network" effects of a platform leadership position, broad array of ISV and IHV certifications, unique vision and culture, and ability to hire superior employee talent" should help Red Hat to continue to grow through the downturn. I concur.
While everyone else lowers its 2009 guidance, Red Hat raised its guidance. While the rest of the market signals weakness, Red Hat has been signaling growth across its product line, and especially JBoss, which can help it move well beyond its operating system roots. Next year looks to be a bright one for Red Hat, just as 2008 has been.