Analyst: Red Hat "deeply undervalued," Oracle Linux "has failed"

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.

Murphy writes:

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.

[Penguinisto]

I'm not surprised, really... One would think that if it were all about simply forking code, CentOS would have squelched RHEL by now (nope - it hasn't... but CentOS makes for one hell of a nice RHEL simulacrum when you're doing testbeds on VMWare-generated virtual machines. :) ).

So we get to vendor support. I'm thinking that the only reason 1 in 32 machines is higher than I thought is because Oracle is scaring the hell out of the newer Oracle-centric DBAs into demanding that Oracle's distro is the only one to run a new Oracle DB on. The old-timers already know better, and multi-platform DBAs already know better.

There is one angle I think you missed: RedHat has the history. Consider that RedHat began back in the days when everyone was either rolling their own, or they were using Slackware, Yggdrasil, Caldera (which was once worth a damn), Debian, etc... RH is one of the few original Linux distro makers to have made it this far and stay successful as a business. That alone says something.

Also, something else to chew on: IBM dumped AIX for Linux, but never decided to make a distro, instead turning to RH. If you look into IBM's reasons why, you'll see why Oracle was foolish about doing their own venture into being a distro-maker. :)

/P

I think a key point is being missed here on the defensibility of Redhat's model. What actual resources has Oracle committed to Unbreakable Linux? My understanding, almost none. The question I would have liked asked by Mark Murphy in his survey is how many of those 32 customers were actually pitched UL? I'm guessing just a few. This whole initiative was a personal Larry Ellison thing, which he is wont to do from time to time, with little planning and little actual commitment of resources over time. This has little to do with Redhat's defensibility and more to do with Oracle's lack of execution. Oracle is not in the operating systems business, Redhat's top line revenue and margins aren't all that exciting to Oracle and with a massive customer overlap this business doesn't offer them much opportunity for new customer acquisition. A look at recent numbers shows that Redhat's total 2009 -revenue- will equal almost exactly -half- of Oracle's -quarterly- net income.

Andrew Aitken

[hawkeyeaz1]

RedHat has also fought against the sirens of Microsoft, and Microsoft has a lot in the way of pressuring (to say the least) the competition.

[masinick]

Red Hat has been a solid company for years. It was among the first to get into the IPO craze during the dot.com days of glory, before the dot.bomb happened. Unlike many of the bombs, Red Hat more than survived. From the beginning Red Hat has been all about developing products and services that are entirely formed around free software. For their offerings to even be noticed, they have to have some value. Red Hat even makes it easy for smaller ventures, such as CentOS to feed off of the Red Hat work, which, of course, is completely fair and in keeping with the GNU and FSF models, which not only encourage, but INSIST upon sharing.

Clearly, then, Red Hat has something to contribute. One, Red Hat knows free software. They know the LAMP software stack. They understand support services, they understand interoperability, and they understand training. They have solid offerings in every one of those areas. Other companies jumping into those spaces cannot simply equal or exceed Red Hat just by "showing up". Red Hat has more than a decade jump on all of them.

While that does not imply that another company with a good model cannot appear and enter into this fray (they can, they just need to do something useful and add a viable alternative) they are unlikely to unseat Red Hat from their well established role, not without providing something infinitely more useful, and I find that not impossible, but quite unlikely.