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Red Hat plummets on 2Q billing shortfall

NEW YORK --Shares of Red Hat Inc., the largest distributor of the open source Linux operating system, plummeted Wednesday, as disappointing second-quarter results, including a slowdown in billings, triggered analyst and investor alarm.

The Raleigh, N.C.-based company's stock plunged $6.17, or 23 percent, to $20.15 in midday trading on the Nasdaq. In the past year, shares have ranged from $16.29 to $32.48.

On an adjusted basis, which excluded hefty stock options expenses, the software company squeaked ahead of the Street view, posting a profit of 11 cents per share on revenue of $99.7 million. Red Hat's outlook just matched analysts' average estimate.

But it was a lackluster growth in billings for the quarter that prompted several downgrades Wednesday morning.

Red Hat told analysts in a conference call that billings, or revenue plus change in deferred revenue, grew 23 percent year-over-year; last year, management said billings grew 58 percent year-over-year.

While Red Hat declined to break out organic billing growth, or growth without taking into account the newly acquired JBoss application server business, analysts were also disappointed with their models for that figure.

Red Hat pinned blame for slowed billings on training around its newly acquired JBoss application server business, restructuring of its sales force in Asia and an increase in the number of three-year deals, which Red Hat accounts for a year at a time.

"The last time the company had a billings growth rate this low was in the fourth quarter of 2005," wrote Prudential Equity analyst John McPeake in a note to investors. "At that time...the company assuaged the markets by quantifying the off-balance sheet backlog increase in the quarter."

This time around, he noted, Red Hat didn't give the hard numbers to soothe investor concerns.

McPeake downgraded Red Hat to "Neutral Weight" from "Overweight" and dropped his price target to $25 from $35.

Jefferies analyst Katherine Egbert also downgraded the stock, cutting her rating to "Hold" from "Buy" and lowering her price target to $24 from $34.

Egbert noted that the company's free cash flow clocked in $10 million short of her estimates, largely due to cash flow demands from the JBoss acquisition.

The analyst wrote that Red Hat's explanation for the drop in billings didn't quite answer all her questions. "We suspect either slowing renewals, increasing price pressure, or weaker demand also contributed to decreased billings, although our checks going into last night's report did not reveal any cracks," Egbert wrote.

"We find management's belief that the lost billings won't return even more ominous, and indicative perhaps of more systemic problems," she added. "It's also plausible that demand for Red Hat Enterprise Linux has weakened as Microsoft has gotten more aggressive and IT budgets have recovered from post-bust levels."

The analyst community was by no means united in its dire reading of the billings slowdown. Merrill Lynch analyst Kash Rangan reiterated his "Buy" rating and $34 price target.

"With unbilled bookings looking good and bulk of JBoss integration behind, we are confident the scenario will repeat and billings growth will resume," he wrote in a note to investors.

Baird analyst Steven Ashley similarly reiterated his "Outperform" rating, though he cut his price target by a buck to $31. "Stock will likely sell-off today, and we would be buyers," he wrote. "We do not believe there has been any change in long-term growth prospects."

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