Behind Red Hat's Consistency: A Surprising Concentration on Investing
Savio Rodrigues is out with a very interesting post on Red Hat's financial consistency. Long story short, he concludes that over the past two years a whopping 48 percent of Red Hat's income before taxes is classified as "Other Income." Specifically, this refers to interest income the company generates and capital gains on investments, and it's clear that the mix between this type of income and earnings generated from the company's core software business are about evenly matched. Is this good or bad?
In a post I did recently on down earnings from Novell and disappointments in the Linux business, I made the point that Red Hat has had far less fluctuation in its quarterly and annual financial performance than Novell has. (The company's stock has also fared better than the competition.) This is partly because Novell is dependent on Microsoft to get new deals within its Linux division, but Rodrigues' analysis of how Red Hat's earnings are structured provides an angle on Red Hat's consistency that I hadn't noticed before.
Red Hat's earnings consistency comes partly from providing good support and services, which has helped them retain their top 25 customers. The company makes this point every quarter when it reports results. Still, though, Rodrigues shows that Red Hat operates substantially like an investment holding company, obviously socking revenues regularly away into interest-bearing investments and investments that produce capital gains.
As a comparison, Rodrigues looks at big companies including Microsoft, Oracle and IBM, all of whom derive less than 10 percent of their earnings from "Other Income" (investments). He also looks at Tibco, to consider how a smaller vendor stacks up, and Tibco gets only 12 percent of its earnings from Other Income.
Over the weekend, the great investor Warren Buffett said that he still sees economic recovery and a better environment for investors coming. Buffett's own company, Berkshire Hathaway, also has substantial investments intended to contribute to earnings.
Red Hat may be much better positioned than other public open source companies to benefit from the rebound if it keeps functioning as an investment vehicle in addition to maintaining its core software and support business. On the other hand, it could take a licking from the amount it invests, as Berkshire Hathaway recently has. I'm betting that Jim Whitehurst and company play investments conservatively, and that we may continue to see earnings consistency from Red Hat.