Shares of Red Hat (NYSE:RHT) are up 24 cents, or 0.6%, at $40.82 despite JP Morgan’s (NYSE:JPM) John Difucci today cutting his rating on the stock to Underperform from Neutral, writing that the company’s projected free cash flow growth of 25% is unlikely to materialize.
At the current price, writes Difucci, the stock is being valued based on future free cash flow growing at 25% per year. However, the company’s only been increasing free cash flow at about 8% per year, he writes. He gives the company the benefit of the doubt that it can increase that rate to more like 15% for a couple of years beyond 2012, which would imply, he believes, a stock value of $32. Should the company not pick up its growth rate, it could be worth as little as $27.
Since growth is unlikely in the company’s core middleware and Linux operating system license businesses, Red Hat would have to materially increase its sales of “virtualization” software, he writes, which he deems unlikely.
“We believe it is risky to assume Red Hat will become a meaningful player in server virtualization at this time,” writes Difucci, noting that customers seem mostly fairly happy with the titan in the business, VMWare (VMW), and that Microsoft (MSFT) and Citrix Systems (CTXS), and Oracle (ORCL) also have designs on that market. Red Hat has no clear advantage over those other contenders, he writes.
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