Paul Rubens at ServerWatch surveys the relative valuations of Sun and Red Hat:
Let’s take a look at Sun Microsystems, the once mighty Unix vendor and maker of servers that powered the Internet, circa 1982. And Red Hat, a company that’s been purveying Linux software since 1995. Sun sells more than $13 billion of goods and services per year, while Red Hat sells a little over $600 million. So which is worth more?
Ask the market (and remember the market is not stupid, at least not in the long term), and the answer is that they’re both worth about the same: Both companies are currently valued by the market at about $2.7 billion. (Actually Red Hat is worth more than Sun today — which is a story in itself.) Sun’s value has been dropping like a stone over the past few months, while Red Hat’s has been soaring — almost doubling since mid-November. Today it’s up almost 2.5 percent.
Sun has a longer but somewhat tattered pedigree than Red Hat, and has 20 times the revenue. Why does the much smaller Red Hat deserve a $3B valuation? What is the market factoring into the equation?
First of all, Sun has cash reserves of $3B, which means the market is valuing its future business — which is tied up with Unix, and a lot of unglamorous hardware — at zero.
That leaves valuation on an earnings basis. The company’s earnings per share (EPS) on a historic (ttm) basis is about 41 cents. With the share price standing at $14.98, that puts the Red Hat on a price/earnings (P/E) ratio of 35.84. Which is very high indeed in the current market climate.
An uncommonly high P/E ratio might mean that the market has very high hopes for Linux in general, and Red Hat in particular. And that might make sense in the current economic climate. With tough trading conditions and sales plummeting for many businesses, open-source software sounds mighty attractive (without going in to the features and benefits and the whole cost of ownership thing). When markets get an idea in their head, money tends to flock to the obvious stocks — and Red Hat is arguably the brand in enterprise Linux. A P/E of 35 would then imply that the market expects some serious earnings growth from Red Hat — and perhaps Linux more generally — in the foreseeable future.
I agree with this analysis. In a time of unprecedented economic pressures companies will reevaluate ever expense, and many will look at the ongoing investments that they are making in servers and server software. Red Hat stands to benefit as companies trickle or surge off of Unix onto Linux.
Secondly, the market may be expecting an acquisition, as Rubens suggests, too, and are factoring in a multiple based on that.
Matt Asay of The Open Road suggests that the obvious link up — Sun buying Red Hat — would make real sense for Sun.
Personally, I think IBM would be the obvious match-up, since they have really moved away from their own proprietary operating systems for the general server market, and are one of the major proponents of open source in the enterprise.
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