I put a quick post up yesterday noting Novell's improved earnings last quarter, and wanted to follow it up with Jason Maynard's (Credit Suisse) more studied analysis. Net net: the company seems to have stabilized but the long-term benefits from selling out to Microsoft aren't going to sell.
Q3 results came in above our estimates and consensus due to higher professional services fees as well as improved expense controls. Despite the outperformance, the company did not change its revenue and earnings goals for F2007, but management did indicate they expect to exceed its operating income target range of $0-10M.
Looking at the combination of Q2 and Q3 results, we think the overall business has stabilized. For the first time in 6 quarters, total revenue did not decline on a Y/Y basis, and after 2 consecutive quarters of margin improvement, it appears that Novell is doing a better job managing expenses. The company is also ahead of pace to achieving its financial goals for the year.
Although we acknowledge the improvements to the business, we continue to believe there are better relative investments within the group....Novell has over $1B in net cash on its balance sheet, however the company is still reluctant to repurchase stock. We think it's most likely that the company uses its cash reserves to make acquisitions, which could also limit near-term upside in the stock. As a result, we are maintaining our Underperform rating....
Total Linux invoicing grew to $38M in the quarter from $29M in Q2. Organic Linux invoicing came in at $24M, compared to $14M in Q2, while Linux revenue was $21M, up from $19M in Q2. Approximately 44% of the $240M in Microsoft coupons have been invoiced to date (3 quarters into the agreement). This metric is important because Novell will not collect any new cash from the arrangement until contracts begin to renew (approximately 2-3 years from now) or Microsoft purchases additional licenses. We remain skeptical that Microsoft will re-up for more coupons, and we don?t think the organic Linux business is growing fast enough to accelerate cash flow growth.
Novell needs a new trick. I think it's doing a better job of selling value, rather than patent FUD. But it needs to keep improving.