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Cowen Says Hold; A Buyout’s Unlikely

A day after the second-biggest Linux vendor, Novell (NOVL), was offered $2.2 billion to merge, Cowen & Co.’s Gregg Moskowitz initiated coverage of the biggest, Red Hat (RHT), with a Neutral rating, writing that while Red Hat’s business is rebounding, its stock is rich and some of its opportunities are not as verdant as they once were.

Red Hat has been very successful at turning users of the free Linux operating system into paying customers who receive support and upgrades on a subscription basis, creating a nice annuity revenue stream.

Moskowitz notes that the company’s growth in revenue coming out of balance sheet as its realized, called billings, is set to rebound, which is a good sign. Billings growth was a heady 25% to 35% in 2006 to 2008, but slowed in fiscal 2009 to 18% and to 11% in fiscal 2010. However, he sees billings rebounding by 20% in 2011 and by 17% in 2012.

The company’s also done a “very effective job” of growing a market for JBoss, a set of tools for enterprise servers that Red Hat bought in 2006.

However, there’s little room for upside to Red Hat’s projected billings growth, as the Unix server market has been plowed for many years by Red Hat and there are fewer converts there to win.

The stock seems priced for perfection, given that it trades at about 27 times as a multiple of enterprise value to free cash flow, which is just below the 28 times to 29 times given to “software as a service companies,” which are set to grow faster than Red Hat.

At that premium valuation, Moskowitz thinks it’s improbable, though not impossible, Red Hat will get bought out. IBM (IBM) and Oracle (ORCL), he notes, don’t generally pay high multiples to free cash flow or revenue.
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