Red Hat (RHT), a company engaged in providing open source software solutions, including its Red Hat Enterprise Linux and JBoss Enterprise Middleware, will discuss results of its second quarter fiscal year 2014 on Monday, September 23, 2013.
However, the factors surrounding this report are not looking rosy compared to previous reports. In the past four years, RHT has topped Wall Street’s consensus estimate 10 times, hit street’s target five times, and tossed in one earnings miss – and this time it looks as if there will be another miss according to present comments and actions of analysts, hedge funds, insider sales, short-interest data and put options activity.
As if there are not enough negative factors already, the company is experiencing cost increases as well as a drop in web search intensity.
Therefore, some concerns exist heading into Monday’s results. One bright spot came after reviewing Q1’s 10-Q — the company’s Subscriptions and Training & Services segments have grown at 15.87% and 12.53%, respectively, year-over-year.
A major concern is that costs to manage these segments have increased at a faster pace than sales. Subscriptions expenses rose while Training & Services were in line, but Subscriptions account for 87% of revenue.
Also, web search intensity was down 6.6% in Q2 relative to Q1. Last quarter, RHT earned $0.32 per share. If Google Trends translate, a 6.6% dip would put EPS at $0.26, which is definitely nowhere close to analysts’ target of $0.33.
Factor in costs rising faster than sales, and eating up a larger percent of revenue, then any pause in demand could make it really difficult for Red Hat to make the number.
Even though open interest favors bulls by a 1.3 to 1 call-to-put ratio in the short-term; longer term put options appear to be outweighing call options.
The last couple of days’ volume, while small, is heavily slanted on the put side of the table, particularly in the October $45 and the January 2014 $42 strike prices.
Many of the hedge funds are reducing their exposure in Red Hat in preparation for the third quarter — a change of -14% from one quarter earlier.
Alkeon Capital Management cut the biggest investment of the “upper crust” of funds, valued at an estimated $114.2 million in call options, and ZWIEG BIMENNA PARTNERS was right behind this move, as the fund said goodbye to about $55.6 million worth. Total hedge fund interest dropped by 5 funds heading into Q2.
Many Insider Sales
Over the last six-month time period, Red Hat has seen zero unique insiders buying, but 10 insider sales – maybe a lack of confidence in the company’s forward progression is apparent.
Short Sellers Plentiful
It appears that RHT has a high “days to cover” value and therefore would be considered to have a high level of short interest. This could mean short sellers are using the stock to hedge a long bet elsewhere, or, in this instance, could also mean that short sellers believe the price of the stock will decline.
Investment analysts at JP Morgan Chase (JPM) lowered their price target on shares of Red Hat from $43.00 to $39.00 with an “underweight” rating on the stock. JP Morgan’s price target suggests a potential downside of 20.34% from the stock’s previous close.
They said, “We believe that Red Hat’s growth has and will likely continue to decline despite management’s comments of large deals signed and additional runway. Although management has attempted to supplement its RHEL success with Virtualization, Middleware, Storage, and Cloud, declines in true growth seem at odds with this expansion.”
With so many negatives surrounding Red Hat’s upcoming earnings report an opportunity has been presented to make a nice 100% profit!
Take advantage of the following options put:
OPTIONS TRADE: Buy the RHT January 2014 42.000 put (RHT140118P00042000) at or under $0.50, good for the day. Place a protective stop limit at $0.20 and a pre-determined sell at $1.00.
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