Will Samsung Mobile App Deal Lift Red Hat Stock?

  • Red Hat has announced a new partnership with Samsung to create enterprise-ready mobile apps
  • The new apps together with Red Hat's cloud platform will help Red Hat to continue diversifying its business
  • Red Hat shares have limited near-term upside potential but good long-term potential

Leading open source software company Red Hat (NYSE:RHT) has announced a partnership with Samsung to create enterprise-ready mobile apps, shortly after the company launched its much-awaited mobile app platform. The deal appears to be very similar to the Apple (NASDAQ: AAPL) partnership with IBM (NYSE: IBM) that was announced late 2014 to create similar apps.

What is the real potential of the new mobile apps and how can it impact Red Hat? Red Hat’s shares have remained surprisingly flat despite the company handily beating on both top and bottom line expectations a few days ago. This has probably been caused by the rather rich valuation of Red Hat shares(currently trading at PE ratio of 83), and partly due to the fact that the investing world still seems to under-appreciate the true potential of Red Hat’s open source cloud platforms, OpenStack and OpenShift. Both cloud platforms have been very well received in the enterprise world and have helped Red Hat to diversify from its core Linux offerings.

Huge Opportunity In Red Hat Stock?

It’s worth noting that Samsung has been credited with the success of some of the leading enterprise software products from BlackBerry (NASDAQ: BBRY). For all its troubles, BlackBerry has been recording phenomenal success selling enterprise software. The pivotal division grew 150% Y/Y during the last quarter, courtesy of red-hot products such as BlackBerry’s latest Enterprise Mobile Management, or EMM, platform, BES12. Samsung is a major reseller of BES12, thanks to its dominance in the Android smartphone market. iOS still leads the global enterprise mobility market with a 72% market share, followed by Android with 26% share. Apple and Samsung mobile devices accounted for a whopping 28 out of 30 new mobile phone activations during the first quarter. Red Hat certainly picked a great partner for its new enterprise mobile apps.

The second big positive for Red Hat’s mobile apps is that unlike Apple-IBM mobile apps that are designed to run exclusively on the iOS platform, Red Hat-Samsung apps will run on Android as well as other mobile operating systems thus potentially giving them a bigger reach. One reason why BlackBerry’s BES12 has been doing so well lies in the fact that it supports nearly all major mobile OSs. This makes it cheaper for organizations with multiple operating systems to deploy. BES10, the precursor to BES12, was unable to support some major mobile OSs including Android which made it unattractive for many organizations. Unlike Apple, Red Hat does not own a mobile OS and therefore does not have its hands tied.

But what is the monetary opportunity for enterprise mobile apps? It all depends on the mobile software niche that Red Hat and Samsung plan to exploit. For niches such as EMM, the opportunity is sizable. Gartner estimates that mobile IT management software costs $55 per device. According to the IDC, the total number of activated enterprise smartphones clocked in at 498 million devices in 2014 and was expected to grow at 21% CAGR to hit 887 million devices by 2017. This in turn means that this mobile software segment alone is currently worth around $33.1 billion and can grow to $49 billion by 2017. That’s much faster growth than the anemic 3% growth IDC projects for enterprise IT spending over the period.

The overall global enterprise mobility market is expected to grow from $72 billion currently to $284 billion by 2019, almost quadrupling in size. There is no question that mobile apps are poised to soon become a big part of enterprise IT spending. This coupled with the fact that the Red Hat apps will run on a diverse range of mobile OSs gives them good market potential.

Red Hat Has Good Overall Growth Potential

Perhaps short-term investors have been overlooking the fact that Red Hat now has multiple growth drivers as opposed to the past when it relied almost entirely on Linux products to drive its top line. Red Hat has been able to successfully integrate its open source OpenStack IaaS and OpenShift PaaS cloud platforms. RBC analysts project that Red Hat will be able to increase its revenue from traditional Linux products from 31% currently to 46% by the end of the year. That’s remarkable growth. Most of this is being driven by the two cloud platforms. The new Red Hat enterprise apps will be built around OpenShift.

Given the Samsung app deal and the new cloud revenue streams, Red Hat should have little trouble maintaining 16% revenue growth over the next five years and earnings growth of 15%. Zack Research estimates that Red Hat’s PE ratio will average 70.9 in 2015 but will fall to around 41.1 in 2018, which is close to the industry average of 44.

Red Hat PE Trends

Red Hat PE

Source: NASDAQ

Should this scenario unfold, then Red Hat shares should be able to grow at 12% CAGR through 2018. I however, believe that the market will still value the company significantly above the industry average by 2018, so I predict a faster 13.5% CAGR share growth through the forecast period. The shares, however, might only have limited near-term potential. I'm long Red Hat.

Also see: Amigobulls' Red Hat Stock Analysis video for a quick look at the company's key fundamentals.

Brian Wu Brian Wu   on Amigobulls :

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