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WIKI ANALYSIS
Red Hat is the world’s leading provider of open source software. Seeking to attack the 40-60% of company IT budgets that are consumed by operating and maintenance costs, open source is considered a cheaper and more flexible alternative to licensed models of software for company IT departments. Red Hat currently maintains about 60% of the Linux market for software products, and with its consistent high growth, the company is investing in the future as open source and Linux continue to gain popularity.
Business Financials
Business Model
Revenue comes from two sources: software subscriptions and training and services. The company makes about 85% of its revenue from software subscriptions, whi ,,ch include set-up, ensurance of compatibility with existing software, and other services involving upgrades and trouble-shooting. In fact, Red Hat derives its revenue from these services rather than the software alone. The remaining 15% from services that include advanced technical support, hourly consulting, engineering, and customer training and education services.
Red Hat employs an open source software model. It opens up software code to innovation from an international community of contributors while licensing and selling software that has been tested for reliability and interoperability with a variety of popular applications. Leveraging the volunteer community of users working to improve the code, RHT sells its software for prices often under-cutting their competitors.
Red Hat generates nearly 60% of bookings through channel partners. Dell, Hewlett Packard, IBM and system builder Sun Microsystems (JAVA) are some of the larger Red Hat partners. The company seeks to increase that share by launching a partner portal that simplifies the ordering of Red Hat applications for distributors.
Financials
For the fiscal year ended February 28, 2007, total revenue increased 44% to $400.6 million from $278.3 million the year before. Within the past three years, Red Hat has seen consistent rapid growth since 2003, with revenue increasing around 40-50% every year.
The increase in revenue resulted primarily from an increasing global willingness to switch to open source and Linux, and an increasing adoption of Red Hat Enterprise Linux as the primary computing platform by large companies. The popularity of Red Hat has created an increase in demand for subscriptions, which in turn drives the need for training of Red Had Certified Technicians, Engineers, and Architects. However, training revenue has increased at a much slower pace than subscriptions revenue, increasing only 40% since 2003 while subscriptions have increased by more than 600%. Subscriptions now compose 85% of total revenue, bringing in $342.2 million to Red Hat.
In addition, revenue resulting from the June 2006 acquisition of JBoss contributed approximately $23.1 million to the $122.3 million overall increase in revenue.
| Year Ended, (in $ thousands) | 2007 | 2006 | 2005 | 2004 | 2003 |
| Subscriptions Revenue | $341,206 | $230,444 | $151,125 | $82,408 | $47,941 |
| Training and Services Revenue | $59,418 | $47,886 | $45,341 | $42,329 | $42,334 |
| Total Subscription and Training and Services Revenue | $400,624 | $278,330 | $196,466 | $124,737 | $90,275 |
Costs are about 7-8% of revenue. Software subscription costs have decreased as a percentage of revenues due mainly to newfound efficiencies in electronic delivery of software, but training and services is much more costly, growing both in absolute numbers and as a percentage of its revenue.
| Year Ended, ($ in thousands) | 2007 | 2006 | 2005 |
| Cost of Subscriptions | $27,457 | $21,003 | $13,488 |
| Cost of Subscriptions, % of Subscriptions Revenue | 8.0% | 9.1% | 8.9% |
| Cost of Training and Services | $37,279 | $27,504 | $24,999 |
| Cost of Training and Services, % of Training and Services Revenue | 62.7% | 57.4% | 55.1% |
| Research and Development | $71,038 | $40,883 | $32,626 |
Key Trends and Forces
- Virtualization is hot: Virtualization is an IT technology that allows multiple operating systems to run on a single machine. The recent popularity in virtualization has two important implications for Red Hat:
- Certain applications work best on particular operating systems, so businesses have historically run multiple machines, each with a different OS (Windows, Linux, Mac, etc.), in order to be able to use all their required software. Virtualization allows companies to run all necessary applications on their respective operating systems simultaneously on a single machine. To combat Window's agreements with PC makers to sell pre-installed software, known as the Windows Vista Effect, virtualization will allow a single machine with Windows already installed to also run the Red Hat open source OS as well without the need for a new computer.
- The Rise of Linux: Because of the increasing popularity of virtualization software, Linux has the fastest growing popularity of any enterprise OS on the market. Linux revenues grew by 67% worldwide revenue in 2006 alone. In 2007, Linux again saw double digit growth and increased their market share for servers to 12.7%, although Linux is still far from reaching Windows' almost 60% market share. Since Red Hat's major operating system platform runs on Linux, its rise is a double edged sword. While on one hand, Linux popularity may increase Red Hat's acceptance, on the other hand, given this growth in the Linux market, infrastructure giants like International Business Machines (IBM) and Oracle could stop supporting vendors like Red Hat and Novell and start producing their own versions of Linux.
- Acceptance of Open Source is increasing at the enterprise level: Increasingly, enterprise customers are finding that closed source software, like the Windows ecosystem, do not have all the capabilities that they need. While open source software may not come with all possible features, IT departments can easily change the source code of an open application to create, change, and remove software functions. This allows companies to cut costs, as they can change a single program to have the functionality of what two or more programs would have had. This new method of using unrestricted development and exchange to increase efficiency has been termed Enterprise 2.0, and has great potential to benefit Red Hat as Linux is the most commonly used open source platform at the enterprise level.
- Government policies in favor of open source software: There is a trend towards governments around the world encouraging the use of free or open source software (so called 'FOSS policies'). These either mandate the consideration or use of Free / Open Source software, or the use of open standards for document file formats, in preference to closed proprietary standards. This trend should create more customers for Red Hat. Red Hat is already preparing for this increase by ramping up marketing and sales and R&D, especially in areas outside the U.S.
- Intellectual property issues: Rival Novell (NOVL) signed a partnership with Microsoft (MSFT), paying royalties in return for Microsoft's promise not to pursue the intellectual property (or IP) violation problems that frequently affect open source software companies. IP problems arise when open source programmers use techniques patented by licensed software sellers, and companies that build off these programs sell them for profit. Microsoft is now pressuring Red Hat to sign a similar agreement or face IP legal repercussions, but so far Red Had has refused. IP is a complicated arena that could drain Red Hat's resources if Microsoft decides to pursue this track.
Competition
- Novell (NOVL): With 30% of the Linux market, rival Novell is number two in the open-source arena but has seen profits drop in the past few years. Unlike Red Hat, Novell licenses its software to sell. However, Novell recently forged a partnership with rival Microsoft (MSFT) that included a reseller agreement that sees Microsoft distributing subscriptions to Novell's SUSE Linux software, joint research and development operations, royalty payments from Novell to Microsoft, and an agreement from Microsoft not to file patent-infringement charges. Dell has already announced plans to support Microsoft-Novell in addition to its current support of Red Hat.
- Oracle (ORCL): Although not a direct competitor for Red Hat, this relatively new firm which focuses on company database software has seen solid growth in the last two years and nonetheless competes to serve company IT departments. Oracle's open source revenues are small when compared with Red Hat's ($14 million versus $400 million), and its best growth opportunity lies in On-Demand remote servers, a track that Red Hat is not currently pursuing. Oracle does compete with open source vendors in terms of software sales to IT departments, but it also provides and receives support from the open source community in the form of code and testing. This means that Red Hat often needs to work with Oracle’s database and teams even while competing against them.
- Microsoft (MSFT): Microsoft Windows has been and still is the dominant player in the desktop operating system market with 90% market share. As Windows became the dominant OS starting in 1995, Microsoft made deals with hardware producers to sell computers with Windows pre-installed, thus removing the incentive for users to go OS shopping. Thus, all open-source providers, Red Hat included, must battle this so-called Windows Vista Effect in which users are already encouraged to use Microsoft software when they buy their computer hardware.
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