Red Hat takes application development to the bank

Red Hat takes application development to the bank
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The open source juggernaut's remarkably steady growth depends less on Linux every year

Ho-hum, another impressive quarter from Red Hat.

The open source leader has made a habit of churning out consistent, profitable growth, even as its would-be open source peers rake in billions from VCs only to see it evaporate in the frenzied pursuit of paying customers. I've suggested that such companies need to become boring like Red Hat, but Red Hat's growth no longer looks pedestrian.

In fact, in its first quarter of the company's fiscal year (FY 2017), Red Hat is showing signs of becoming a serious staple of enterprise computing for decades to come.

The numbers don't lie

Red Hat pulled in $568 million last quarter, $502 million of which was subscription revenue. This represents 18 percent growth over last year and also came in above the high end of analysts' expectations. The company's stock has taken a 5 percent tumble on the back of weaker-than-expected guidance for next quarter, but these investors aren't paying attention to the long term.

In the long run, John Maynard Keynes reminds us, we are all dead. But based on some key Red Hat numbers, it may still be chugging along.

One area that demonstrates Red Hat's growing strategic importance within the enterprise is the number of large deals the company can generate. In Red Hat's first quarter of its fiscal year 2017, the company popped the champagne on 45 deals over $1 million. For those keeping score, that's up 50 percent year over year.

Of Red Hat's top 25 customers up for renewal in the quarter, every one of them renewed (at 110 percent of the original contract value, if we exclude government contracts, which drag the number down to 105 percent).

As Frank Calderoni, Red Hat CFO, told investors:

This traction highlights Red Hat's growing strategic importance in our customers' data centers and our talented sales teams' ability to land and expand our wallet share of IT dollars. Cross-selling was strong, with a record high of 80 percent of the top 30 deals, including one or more components from our group of application development and emerging technologies offerings.

Just as important, however, is Red Hat's growth beyond its traditional Linux business.

The world is increasingly composed of software, and most of that software is open source. It's a perfect storm for Red Hat, which makes its money taking complex, open software and making it easily digestible for the enterprise. Red Hat CEO Jim Whitehurst confirms: "We are uniquely capable just from what we've done for over a decade at taking open source software and making it supportable, consumable, and life-cycle managed for enterprises."

This shows up in Red Hat's diversifying revenue mix. Not surprisingly, subscription revenue for the company's infrastructure-related offerings (like Red Hat Enterprise Linux) was $403 million, an increase of 14 percent year-over-year. As nice as that is, it's even nicer that Red Hat's subscription revenue related to application development and emerging technologies was $98 million, an increase of 39 percent year-over-year.

While that latter revenue is still just 17 percent of total revenue, it's growing much faster, pointing to a Red Hat that depends less on Linux every year.

Where do we grow from here?

Given the importance of cloud to enterprises and the seemingly unstoppable juggernaut that is Amazon Web Services, Red Hat needs growth to come from its cloud businesses. Of the two -- OpenShift and OpenStack -- OpenShift looks more promising.

OpenStack is generally going to serve the laggard, i.e. the company that isn't quite ready to do cloud right and go all-in on public cloud. I'm inclined to believe that hybrid cloud is a transitional phase for enterprises as they get comfortable with the cloud, and that paints a rather dim future for OpenStack.

That's not to say Red Hat won't cash in on these Nervous Nellie cloud buyers. They will. But my bet is on OpenShift to drive Red Hat's cloud business long term, because it delivers an AWS-like experience. While most of Red Hat's OpenShift customers still use it on-premises, that will change as they grow comfortable with the cloud.

At any rate, although Red Hat "announced more new customers at OpenStack Summit than everybody else combined," according to CEO Whitehurst, those customers aren't yielding real money. Not yet. Whitehurst said that Red Hat's OpenStack revenue is still "quite small," and almost "immaterial." While the company definitely has customers in production, "rarely do you see a $1 million initial deployment of OpenStack."

Regardless, Red Hat is now on the path to $5 billion in annual revenue, a number Whitehurst has said the company can hit with its current product mix. Given that the world increasingly builds with open source infrastructure, that's a pretty safe bet.

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