The narrow-moat company faced several headwinds last quarter that we view as temporary.
By Rodney Nelson | 12-22-16 | 02:19 AM | Email Article

 Red Hat  delivered third-quarter results that came up short of our expectations, as the company faced several headwinds that we generally view as temporary. Consistent with other recent software results, management cited foreign exchange headwinds as a contributor to the revenue shortfall, while the company is also seeing some delays in deal-making with the U.S. federal government in the wake of the presidential election. Moreover, CFO Frank Calderoni has announced he is leaving the firm in January to become CEO of another firm, while vice president Eric Shander will assume the role in the interim. While management modestly lowered its full-year guidance, we believe these headwinds will abate over the long term, and we are maintaining our $84 fair value estimate and narrow moat rating.

Rodney Nelson is a senior equity analyst for Morningstar.

Third-quarter revenue rose 17.5% year over year to $615 million, including a $3 million headwind attributable to foreign exchange (which would have brought Red Hat’s top-line results in line with our estimate). The impact is expected to intensify in the fourth quarter, yielding roughly $16 million in top-line headwinds that plays a significant role in management reducing revenue guidance for the year by roughly $40 million. Management also called out challenges in the public sector, as deal-timing has slipped somewhat in the current quarter, though these deals are still expected to close. The firm continues to excel at delivering solid operating margins, and we were encouraged to hear management reiterate its full-year operating margin guidance, despite the lowered expectations for revenue. Diluted EPS came in at $0.61, slightly ahead of our expectations on the back of strong operating expense controls.

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