Red Hat's fourth quarter earnings: The server upgrade stars lining up

Red Hat's fourth quarter earnings are expected to show strong results as the server upgrade stars line up in the company's favor.

Red Hat's fourth quarter earnings are expected to show strong results as the server upgrade stars line up in the company's favor.

Wall Street is expecting revenue of $193.2 million with earnings of 16 cents a share. Gross margins are expected to be 85.89 percent. For fiscal 2010, Red Hat is expected to report earnings of 68 cents a share on revenue of $745.5 million.

Analysts, however, widely expect Red Hat to hurdle those targets and provide a relatively optimistic view of fiscal 2011. Wall Street expects Red Hat to report fiscal 2011 earnings of 76 cents a share on revenue of $842.3 million. For the first quarter, Red Hat is expected to report earnings of 18 cents a share (actually 17.7 cents a share) on revenue of $199 million.

Simply put, Red Hat is on a roll and expected to keep momentum going. Why? Analysts note a few key factors. Among them:

The server upgrade cycle. Companies are buying servers again and there's pent-up demand for the latest, more efficient models. Meanwhile midrange servers---x86 shipments---are showing the most demand. Add it up and William Blair analyst Bhavan Suri expects that server demand to translate into more subscriptions to Red Hat Enterprise Linux.

Red Hat is gaining more IT wallet share. Piper Jaffray analyst Mark Murphy said in a research note:

Recent conversations with 44 Red Hat partners point to a steady improvement in the operating environment, an increasing pace of Unix-to-Linux migrations, and Q4 results that successfully attained plan. In our view, the positive feedback indicates Red Hat is rapidly gaining greater share of IT budgets due to a superior price/performance proposition.

Sun's departure from the commodity server market. Suri also noted that Oracle completed the Sun purchase and said it was out of the commodity box business. As a result, Red Hat is most likely picking up a few former customers of Solaris---Sun's server operating system.

Suri said in a research note:

Our checks indicate that a number of Solaris x86 customers have migrated to IBM’s System x servers, which would most likely be using Linux as an operating system, proving incremental Red Hat subscription revenue in the quarter.

However, Jefferies analyst Katherine Egbert said the Sun equation remains volatile. She said:

It remains unclear how Oracle's recent purchase of Sun Microsystems might affect the server OS market, but we think it's likely that Oracle will set pricing on Solaris at levels that make it attractive for customers not to switch.

Linux is gaining market share in the server market at the expense of Unix. That's another trend that benefits Red Hat. For instance, IDC reported that Linux server revenue was up 6.1 percent to $1.9 billion in the fourth quarter, but Unix sales fell 18.1 percent. Linux is 14.7 percent of the server market compared to Unix's 29.9 percent.

From Murphy's survey of Red Hat partners:

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