I Wouldn’t Look Down If I Were You

When an Internet company announces quarterly earnings that fail to meet
analysts’ expectations and posts a relatively modest 63 percent in quarterly
revenue growth over the previous year, you would expect its stock to
take a pounding from the market.

Unless, of course, the company and its stock are floating on that bubble
within the Internet bubble: Linux.

Linux, of course, is the free operating system software that some
believe (and many hope) will dislodge Microsoft Windows’ iron grip on
the computer software market. While it’s too early to tell if Linux
poses a genuine threat to the Redmond giant, the technology clearly
possesses the power to scramble the minds of investors.

The latest beneficiary of the Linux-or-leave-it craze is Red Hat Inc. (RHAT).
Before the opening of trading Monday, Red Hat released its first
quarterly earnings report since going public way back in August
(becoming the first Linux company to hit the street).

The company’s revenue was $5.4 million in the quarter ended Nov. 30, up
from $3.2 million in the year-ago quarter. In a market where any number
of Internet companies routinely show quarterly revenue gains of 100% or
more, that 63 percent growth alone normally would give investors pause.

And it did, but that’s about all it was, a pause. After dropping
slightly in early trading, shares of RHAT on Monday afternoon were up
more than 12 percent to 265 from Friday’s closing price of 252-7/8, despite
also reporting a 5 cents per share net loss that exceeded consensus
estimates of 4 cents per share.

Investors (at least for the moment) are willing to forgive those numbers
for two reasons: 1) Red Hat took the opportunity Monday to also announce
a 2-for-1 stock split, and 2) hey, it’s Linux, isn’t it?

Monday’s surge gives Red Hat a market capitalization of $17.6 billion.
Only 11 other Internet companies are valued higher, and all but one have
more revenue than Red Hat. Based on estimated fiscal year 2000 revenues
of $25.1 million (taking the three quarters already reported and CEO
Matthew Szulik’s $12.5 million forecast for Q4), Red Hat is now trading
at nearly 700x projected revenue.

If you’re a Red Hat employee holding options at the stock’s $14 offer
price, the market’s blind optimism about Linux must be like a holiday
dream come true. Sooner or later, though, like a cartoon character who
can run on air until he looks down and realizes there’s nothing below
him, Red Hat investors buying in at the current premium prices will
become abruptly reacquainted with gravity.


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