Cloud Confusion: Wall Street's Mixed Reaction To Red Hat's Q4

Red Hat Inc RHT reported fourth-quarter results Monday that were more positive than anticipated across the board,  while the software company's guidance for 2019 exceeded Street expectations. Here's how Wall Street reacted to the print. 

The Analysts

• Bank of America Merrill Lynch's Kash Rangan maintains at Underperform, with a price target lifted from $115 to $130.
• Stephens' Jonathan Ruykhaver maintains at Overweight, price target lifted from $135 to $170.
• William Blair's Jason Ader maintains at Outperform, no assigned price target.

Bank Of America: Valuation Concerns

Red Hat's earnings report signals its hybrid cloud strategy is "resonating" with customers, BofA's Rangan said, with a 25-percent compounded annual growth rate spend for customers buying cloud-enabled technologies versus 5 percent for on-premise technologies.

While this is encouraging, a bearish stance on the stock is still justified based on the following factors, the analyst said:

The stock is trading at 24x 2019E EV/FCF, which is at the high end of its historical 13x to 24x range.

EV/NTM FCF to total billings growth has been 1x on average over the past seven years, and the stock's valuation is "well ahead" of the company's billings growth profile.

Margin leverage will likely be "muted" in the near-to-medium-term.

Free cash flow growth through 2019 is now trending below the 20-percent billings growth.

Stephens: Impressive Takeaways

Red Hat showed strength across the board in its earnings report, highlighted by 34-percent year-over-year growth in the app development and emerging products category, Stephens' Ruykhaver said in a research report. Of the company's large deals, 81 percent had some sort of app development or emerging products component attached, the analyst said.

The strength in the services sector reaffirms the value proposition of Red Hat's dev ops offerings, and channel checks confirm an optimistic view on OpenShift "as an agnostic, container-friendly PaaS and Ansible as increasingly important given the adoption of containers." 

Related Link: Mizuho: Red Hat Valuation Leaves Little Room For Upside

William Blair: Not A One-Trick Pony

Red Hat's earnings report marks an end to an "outstanding" year, as the company "proved once and for all that it was no longer a one-trick" Linux pony, William Blair's Ader said. The company has proven it can successfully expand its business to strategic areas, including software containers and infrastructure automation, the analyst said. 

Red Hat is still considered to be one of the best-positioned companies for the "coming wave" of spending on container-based application development, Ader said. While it is becoming more difficult to call for continued margin expansion, Red Hat's expanding market opportunity and expectations for upside to current estimates justifies an ongoing bullish stance on the stock, according to William Blair. 

Price Action

Shares of Red Hat were trading higher by 4.7 percent Tuesday afternoon. 

Related Link:

Nomura: Red Hat Could Have $66 Billion Total Addressable Market By 2020