Red Hat borrows $500 million [LWN.net]

Red Hat has a balance sheet that many other companies would envy. The company was lucky (and smart) enough to be the first Linux company to go public during the brief Linux portion of the dotcom bubble; it even had sufficient time to do a second offering to bring in another pile of cash. That windfall, along with careful management, left the company with $329 million in cash and investments at the end of November, 2003 (the last quarter for which numbers are available). That cash pile has been growing in recent quarters; Red Hat certainly need not be concerned about running out of money anytime soon.

So one might well wonder why Red Hat has just issued $500 million in bonds. Why take on half a billion dollars in long-term (20 years) debt when you haven't really figured out what to do with the cash you already have? We asked the company, and were told:

We decided to take this great opportunity to capitalize our company for the purpose of achieving our goal to become the defining technology company of the 21st century. We are focused on building and expanding our organization long term.

There are no specific plans for the cash at this time.

In other words, they aren't telling. One may well speculate that there are acquisitions (big ones) in the works; this idea is reinforced by this (Raleigh) News & Observer article:

"We believe the time for us as a company to take control of the market is now," said chief financial officer Kevin Thompson. "What we've done is capitalize ourselves so that we can react very quickly to opportunities that come up in the marketplace."

Customers are demanding products that Red Hat can't offer, Thompson said. It likely will have to buy other companies to add new products and services.

One assumes that Red Hat has some "opportunities" in mind, but they are not ready to talk about them at this time.

The truth of the matter is that Red Hat was able to get this money on great terms. The interest rate on this loan is 0.5%. So Red Hat could simply put the money into certificates of deposit (currently paying 4% or so in the U.S. for long terms), pay off the loan in 20 years, and pocket the interest. If Red Hat invests this money in this way, it has just acquired a few million dollars per year in free income for the next two decades. This is not a deal the company could afford to turn down.

The real question, perhaps, is why the (unnamed) investors decided to loan money to Red Hat on such terms. Long-term U.S. treasury bills pay 4.2% as of this writing - eight times what Red Hat is paying. The U.S. government is unlikely to reinvest such money as wisely as Red Hat, but it has the advantage of its coercive powers when payback time comes. Treasury bills pay more, and are safer too.

The answer to that question can only lie in the conversion feature of these bonds. The purchasers can convert the bonds to stock at a rate of about $25/share at any time. That rate is significantly above Red Hat's current stock price ($18.50, as of this writing) but, remember, these investors are working with a twenty-year horizon. The bonds are, essentially, a long-term call option which enables the investors to get their funds back if the stock price never goes above $25. Unless Red Hat goes into bankruptcy, the bond holders will probably do OK.

Red Hat started the first Linux financial boom with its IPO. What we may be seeing here is the beginning of the second, more sustainable boom. Serious money is, once again, flowing into Linux companies. The first boom changed the industry in many ways, and left numerous investors rather poorer than they were before. The second boom may be seen as when Linux really took off; it will doubtless bring changes as well. As always, it is going to be interesting to watch.

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interest-free loan ?

Posted Jan 12, 2004 3:07 UTC (Mon) by stock (subscriber, #5849) [Link]

"Every enterpreneur know: Raise money when you can, don't wait until you
need it (because than it's much harder to get it)."

I agree, when someone's buggering about business, its always about time
and money. (space also of importance?). Anyway having a cash reserve
which responds within seconds is a good thing to have. The 0.1% makes it
almost a interest-free loan, which seems to me like RedHat must have some
Big Dad taking care and act as extra underwriter.

Its a good thing to read, however it depends on what RedHat is going to
do. I'd say the best thing to do is to continue business as usual.
Purchasing some company which cost $500 million, might lead to more
millions of unexpected costs.