While Red Hat ( RHT ) reported in line revenues for Q2 and a $0.02 beat on earnings, billings of $376 million fell short of analyst estimates. Critically, this became a focus during the call. As a general rule of thumb, investors use billings as a key metric for Red Hat given that it measures the change in deferred revenue from the cash flow statement.
According to the company, weakness in Europe and a slower deal environment were the culprit for the deceleration in billings. Specifically, two of the company's largest deals (~$20 million) were billed for only 15% of the total contract value during the quarter. The average contract length was 21 months.
Management also cited summer seasonality, a weak economy, and currency headwinds, which further contributed to the softness in billings. The silver lining came from subscription revenues, which came in slightly ahead of expectations. Moreover, profitability was also ahead with adjusted operating margins at 25.2%, 130 bps above forecasts.
On the earnings call, management gave guidance for Q3, which came in mixed. For Q3, the company guided for revenues of $381-$384 million versus the street at $391 million and non-GAAP EPS of $0.34-$0.35 versus the street at $0.34.
For FY14, the company narrowed its revenue guidance to $1.51 - $1.52 billion, which fell short of the street at $1.53 billion although non-GAAP EPS is expected to be $1.36-$1.38, which is above consensus of $1.35.
RHT is currently trading at 36x forward earnings, which is at a slight discount to its 5 year median of 39x. The company trades at a premium versus competitors Citrix Systems ( CTXS ) at 22x, Ca Inc. ( CA ) at 11x, Microsoft ( MSFT ) at 12x, and Oracle Corp ( ORCL ) at 11x, respectively.
RHT does deserve a premium multiple over CA, MSFT, and ORCL, respectively given the company's low-mid teens earnings growth rate versus the large cap vendors which have low-mid single digit earnings growth rates.
However, given the choppy deal flow for billings, relative valuation, and mixed guidance for Q3 and FY14, a lower multiple in line with its 5 year median (and also closer to its competitor such as CTXS) is likely warranted, such as 30x versus its current valuation at 36x.
Back of the envelope, assuming the company's long term growth rate of 14% (per StarMine) and the midpoint of FY14 guide at $1.35 would imply FY15 EPS of $1.56. At 30x would suggest a target price of $47 (11% downside from RHT's closing price).
As a recap, Red Hat ( RHT ) reported Q2 revenue of $374 million, vs. the analyst consensus of $372 million on Capital IQ. EPS was $0.35, vs. expectations of $0.33 per share.
Subscription revenue for the quarter was $327 million, up 17% in U.S. dollars year over year, or 18% measured in constant currency.
RHT 48.88 -4.05 -7.65
CTXS 74.18 -0.20 -0.27
MSFT 32.70 -0.04 -0.12
CA 30.39 -0.09 -0.30
ORCL 33.81 -0.13 -0.38
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