Red Hat: Linux Pays Off – And Isn’t Bloated

The recession is proving to be an opportune time for Linux vendor Red Hat (NYSE: RHT) as it continues to grow revenues and earnings. According to Red Hat executives, the growth is coming at the expense of rivals and as a result of customer confidence in the abilities of Linux and Red Hat’s JBoss middleware platform.

The growth of Red Hat’s business is not however a sign of bloat. During Red Hat’s second quarter earnings investor call on Wednesday, Red Hat CEO Jim Whitehurst responded to an analyst question about Linux founder Linus Torvalds’ comment earlier this week that Linux was bloated.

“As Linux has continued to grow and its applicability continues to expand, there’s just more feature functionality that people are looking for to be built into the operating system,” Whitehurst said. “I don’t think of that as bloat.”

Whitehurst added that in his view, bloat is when vendors add features that people do not want. Linux, he said, is growing but with features that people do want.

“The key differentiator is it can continue to do that in a very modular way, so I actually look at the growth as much more of a reflection that it continues to add features that people do want, and that’s a good thing,” Whitehurst said.

Red Hat’s customers are seeing it as a good thing too, if the financial results are to be taken as an indicator.

For Red Hat’s second quarter of its fiscal 2010 year, ending Aug. 31, revenues hit $183.6 million. That’s a 12 percent increase over the second quarter of fiscal 2009 and ahead of Wall Street forecasts of $179.1 million, according to Reuters Estimates.

Net income also rose, coming in at $28.9 million, or $0.15 per diluted share — up from the $21.1 million, or $0.10 per diluted share, for the year-ago quarter.

Minus one-time items, the company said it took home a $0.16 per share profit. Wall Street analyst had expected a $0.15 per-share profit.

Moving forward, Red Hat provided Q3 revenue guidance to be in the range of approximately $187 million to $189 million.

How Red Hat does it

The growth of Red Hat’s business is not necessarily a sign of renewed spending in the IT sector. Rather in Whitehurst’s view, Red Hat’s growth is coming by way of taking share from other operating system vendors.

“I would say we are seeing some signs of life out there as customers are talking a bit more about new projects,” Whitehurst said. “But I don’t think we actually saw that in new volume in the second quarter. I think it’s mainly taking share still at this point.”

For example, the current ownership status of Sun Microsystems is creating some opportunities for Red Hat in Whitehurst’s view.

Oracle is trying to acquire Sun in a deal that is currently being held up by approvals in the EU. Sun’s Solaris operating system is a rival to Red Hat Enterprise Linux.

“I think that any time there’s change in a company like what’s going on at Sun, it creates opportunity,” Whitehurst said. “HP, IBM, and Dell are squarely focused on that opportunity and when there are replacements like that in many, if not most cases, Red Hat software is involved, so I would say that we are seeing some opportunity there.”

It’s not just Sun Solaris that Red Hat is winning customers from, but from other Linux distributions as well. Earlier this year, Whitehurst noted that Red Hat was beginning to make a committed effort to target free Linux users for conversion to paying enterprise Linux subscriptions. It’s an effort that is now paying off, the company said.

Whitehurst noted that Red Hat struck two sizable free-to-paid deals during its second quarter.

“One of the free-to-pay deals was a multimillion dollar deal with a financial services customer,” Red Hat CFO Charlie Peters said. “This customer chose to migrate back to Red Hat after using a competitor’s Linux provided to them through free coupons.” While Peters didn’t disclose further details on the parties involved, the transaction may have been related to the Microsoft Novell agreement, which involves Microsoft reselling Linux through a coupon offer.

“This customer returned because our technology roadmap was clear and our value proposition is strong,” he added.

Peters also said that Red Hat’s other major free-to-paid deal was with a large technology company.

“This customer has attempted to support the software themselves but realized that they were incurring significant costs and risks to do so,” he said. “They were able to achieve significant cost savings by buying Red Hat subscriptions and their CIO now sleeps more securely at night.”

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