Option Trade 
Red Hat Inc (NYSE:RHT) Calls
Friday, September 22, 2017

** OPTION TRADE: Buy the RHT OCT 20 2017 110.000 CALL at approximately $2.70. Place a pre-determined sell at $5.40.

Note: No protective stop losses added -- but if you wish to do so make it $1.10.

Also Note: This is a recommendation and individual members can use their own discretion as to when to enter or exit!

by Ian Harvey   

A player in the Technology space, Red Hat Inc. (NYSE:RHT), a global provider of open source software solutions, using a community-powered approach to develop and offer operating system, middleware, virtualization, storage and cloud technologies, will release earnings on Monday, September 25, after the market closes.

The report will be for the fiscal Quarter ending Aug 2017. Analysts' forecast the consensus EPS for the quarter is $0.47. The reported EPS for the same quarter last year was $0.37.

Red Hat has a broad portfolio of trusted and affordable open source operating system applications, including physical, virtual, private and public cloud products. Red Hat utilizes a subscription-based revenue structure. They currently operate in over 35 countries, and are headquartered in Raleigh, North Carolina.

Linux and open-source software vendor Red Hat is more than just a likely source of double-digit returns in 2017. It's a strong candidate to deliver steady returns, including a large number of double-digit jumps.

And Red Hat shares have been delivering exactly that for a while.

The average annual return on Red Hat shares over the last five years was 10.7%. That's actually the lowest five-year compound annual growth rate (CAGR) of the last seven years. On several occasions, Red Hat investors have enjoyed CAGR returns of 20% or more.

The company runs a lightweight, disruptive business model with a sharp focus on high-growth markets. Red Hat Enterprise Linux is already a big name in enterprise computing circles. Going forward, Red Hat is establishing itself as a leader in the emerging OpenStack market while also providing top-notch security solutions for the Internet of Things.

RHT is expected to grow its earnings per share by a robust double-digit 26.95% over the next 12 months. At a current of earnings per share of $1.49, this growth rate means shareholders can expect impending earnings per share of around $1.89. The revenue is expected to grow from $2.52 Billion to $3.59 Billion in 2020 and the net income is expected to grow from $265 Million to $665 Million in 2020, approximately growing 2.5x.

Meanwhile, RHT has appointed Narendra Gupta as chairman of the board. He currently serves on the board of trustees of the California Institute of Technology, which is the advisory board of Asia Society Northern California, and on the boards of several privately held companies.

Additionally, RHT have been awarded a contract from the Department of Homeland Security (DHS) Science and Technology Directorate (S&T) to advance mobile application lifecycle security. In May, DHS S&T announced the findings of its “Study on Mobile Device Security”, conducted in coordination with the National Institute of Standards and Technology and its National Cybersecurity Center of Excellence. Through the DHS S&T Mobile Application Security project, RHT and Kryptowire will help to address the mobile security gap by developing a framework for automation of security and privacy compliance in the mobile application lifecycle

Barclays has raised its price target on RHT to $120 from $105 and maintains an Overweight rating. Analyst Raimo Lenschow expects a strong 1H performance and says the firm’s newest VAR survey points to higher interest in the company’s infrastructure and emerging products, which could help Q2 overcome the comparison to last year’s strong quarter. The analyst cites hybrid cloud deployments by IT leaders as a major tailwind. 

RHT stock has risen 52.6% in this year to date.

Red Hat’s 50 day moving average price is $103.43 and its 200-day moving average price is $93.28. The stock has a market cap of $18.89 billion, a PE ratio of 72.91 and a beta of 1.24. Red Hat has a 12-month low of $68.54 and a 12-month high of $108.39.

Influencing Factors to Consider

Red Hat delivered positive earnings surprise of 7.69% in the last quarter. On an average, the company has delivered a positive earnings surprise of 3.68% in the trailing four quarters.

In fiscal first-quarter 2018, revenues increased 19.2% year over year to $676.8 million, primarily driven by strong subscription revenues and cross-selling of cloud-enabled technology. The figure was better than the Consensus Estimate of $647 million and the guided range of $643-$650 million.

Non-GAAP earnings for the quarter increased 12% year over year to 56 cents per share, which also surpassed the guided range of 52-53 cents per share.

Red Hat stock has gained 53.5% year to date, substantially outperforming the 27.4% rally of the industry it belongs to.

Red Hat's partnerships and complementary acquisitions have led to a favorable product mix, which is in turn boosting the company's top line. It completed the acquisition of the assets of data deduplicator, Permabit in July 2017, which is expected to add to its revenues.

The company's strong partner base that includes the likes of IBM, Intel, Dell Technologies, Google cloud platform, Microsoft MSFT Azure and Amazon Web Services, which also had a recent extended partnership agreement with Red Hat's Openshift is a major tailwind.

OpenStack is an open source cloud operating system that allows businesses to develop their own solutions for any operating needs, resulting in a lean, efficient, and effective private enterprise solution. At the very core of the cloud segment, is its foundation of the Linux software. Red Hat Enterprise Linux (RHEL), while continuing to grow in the mid-teens, will tremendously help to grow another segment of Red Hat's business as they develop and grow their open source cloud software, Red Hat OpenStack. RHEL makes up nearly 67% of the $2 billion Linux market, which will allow them to cross-sell Red Hat OpenStack to new and continuing clients as the shift to the hybrid cloud grows. Red Hat has been actively marketing and selling their emerging cloud technologies, with this segment of their business growing at over a 35% CAGR. The transition to the cloud by companies all around the world will make up an addressable market of $5 billion for OpenStack, and it is believed that Red Hat is in a position to take control of this market by leveraging their successful Linux operating system.

Red Hat is gaining from improving recurring revenues and cross-selling of cloud-based technology. Emerging technologies have also been a driving factor. The company anticipates that revenues from on-demand Certified Cloud and Service Providers (CCSPs) will reach $200 million annual run-rate in the soon-to-be reported quarter.

Deal growth reflects Red Hat's ability to cross-sell products to current customers seeking the on-premise and cloud open source hybrid for their operations. During 3Q 2017, RHT saw their top 25 largest deals renew at a higher price of 120% of their initial value. Also notable, 93% of the top 100, and 84% of the top 1,000, customers are using more than one of Red Hat's technologies. These rates will continue to grow as Red Hat cross-sells Red Hat OpenStack and attempts to capture the $5 billion addressable market. The number of customers that have more than one product will grow with the cloud, and so will overall revenues.

Large deals have continued to be a growing factor for revenues, with deals that exceed $1 million growing at a CAGR of 31% since 2012. The large deal growth with only accelerate with the adoption of OpenStack.

Open Source is expected to succeed with cloud technology because, unlike proprietary operating servers (ex. Windows), each individual developer and company can shape innovated and time-saving systems directly effective for their business.

As well, the company had a significant customer win in the second quarter with the British army migrating its private cloud environment to Red Hat Enterprise Linux and adopting Ansible Tower by Red Hat for the purpose of automation and orchestration. Its customer base also witnessed the addition of Intermountain Healthcare for its digital transformation.

Additionally, the company made a few enhancements to its offerings. Per Red Hat, the industry's first production-ready open source hyperconverged infrastructure (HCI) solution was unveiled by the company during the quarter. The company also expanded its alliance with Microsoft for simplifying the process of adoption of cloud containers.

Analysts and Hedge Funds Opinions

Red Hat, Inc. was upgraded by Zacks Investment Research from a “hold” rating to a “buy” rating in a report released on Thursday. The firm presently has a $120.00 price objective on the open-source software company’s stock. Zacks Investment Research‘s price target would suggest a potential upside of 12.16% from the stock’s current price.

According to Zacks, “Red Hat is benefiting from strong deal win, improving recurring revenues and cross-selling of cloud-based technology. We believe that Amazon Web Services-OpenShift partnership extension reflects strength in Red Hat’s solutions and platform. The acquisition of Codenvy will boost its position in the hybrid cloud computing market. Further, the company has a strong customer as well as partner base that include the likes of IBM, Intel, Dell Technologies, Google cloud platform and Microsoft Azure. We note that the company has outperformed the industry on a year-to-date basis. However, intensifying competition, growing U.S. government exposure and foreign exchange volatility are some of the headwinds, in our view.”

Also, several other equities analysts have recently commented on the company…..

  • Stifel Nicolaus reissued a “buy” rating and issued a $115.00 target price on shares of Red Hat in a report on Wednesday.
  • Drexel Hamilton reissued a “buy” rating and issued a $127.00 target price on shares of Red Hat in a report on Tuesday.
  • Wells Fargo & Company reissued an “outperform” rating and issued a $120.00 target price (up previously from $115.00) on shares of Red Hat in a report on Tuesday.
  • Royal Bank Of Canada lifted their target price on Red Hat from $106.00 to $121.00 and gave the stock an “outperform” rating in a report on Wednesday.
  • Finally, Barclays PLC lifted their target price on Red Hat from $105.00 to $120.00 and gave the stock an “overweight” rating in a report on Monday.

Ten investment analysts have rated the stock with a hold rating and twenty-six have assigned a buy rating to the company’s stock.

Several institutional investors have recently made changes to their positions in the stock…..

  • FMR LLC increased its holdings in shares of Red Hat by 10.8% in the second quarter. FMR LLC now owns 11,165,642 shares of the open-source software company’s stock worth $1,069,110,000 after purchasing an additional 1,085,953 shares during the last quarter.
  • Jericho Capital Asset Management L.P. bought a new stake in shares of Red Hat in the first quarter worth about $92,816,000.
  • Arrowstreet Capital Limited Partnership increased its holdings in shares of Red Hat by 282.6% in the second quarter. Arrowstreet Capital Limited Partnership now owns 1,177,208 shares of the open-source software company’s stock worth $112,718,000 after purchasing an additional 869,550 shares during the last quarter.
  • Northern Trust Corp increased its holdings in shares of Red Hat by 28.8% in the second quarter. Northern Trust Corp now owns 3,794,946 shares of the open-source software company’s stock worth $363,365,000 after purchasing an additional 848,777 shares during the last quarter.

Harvey’s Options Volatility Indicator


On the whole, RHT looks like it is well-placed to deliver solid growth in the upcoming year, supported by analysts’ double-digit growth projections.

Therefore, looking ahead, there is no reason why Red Hat's rock-steady returns should slow down anytime soon.

Red Hat's top-line sales growth is accelerating while earnings have skyrocketed in recent quarters. Share prices have seen solid gains.

Therefore, based on the facts above, and Harvey’s Options Volatility Indicator, the following option trade is recommended…..


** OPTION TRADE: Buy the RHT OCT 20 2017 110.000 CALL at approximately $2.70. Place a pre-determined sell at $5.40.

Note: No protective stop losses added -- but if you wish to do so make it $1.10.


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