Is Red Hat in financial trouble? [LWN.net]

Is Red Hat in financial trouble?

Posted Feb 28, 2011 19:49 UTC (Mon) by hp (guest, #5220)
In reply to: Is Red Hat in financial trouble? by NightMonkey
Parent article: Red Hat's "obfuscated" kernel source

Something that's underappreciated in the open source world, I think, is that Red Hat's stock price basically assumes that they can somehow increase margins a fair bit. The stock is badly overpriced (in my opinion) if you assume that they cannot improve margins. (I'm not saying it's a bad company, I'm saying the present value of their future cash flows is not worth their market price, at current margins. It would be worth some lower market price. Lots of great companies aren't for sale at great prices.) There's some amount of acquisition-speculation with Red Hat stock as well, probably, in addition to future-margin-expansion speculation.

To date Red Hat has always grown revenue by growing costs also, and they just are not that profitable compared to a Microsoft or an Apple or other proprietary software companies.

I think Red Hat would say that this is because they're still investing in the business and don't want to just hoard cash when they can build the business instead. Whether you believe this is a key question if you are investing in Red Hat.

So what they have to do _eventually_ is somehow increase revenue without increasing costs. This could mean raising prices, or just using their resources more efficiently, or whatever it is.

But, you should expect Red Hat to feel pressure to expand margins and act accordingly. In this sense they are in "financial trouble" - it's not that they're going to go bankrupt, but unquestionably current investors in Red Hat expect them to become more profitable than they are today. And Red Hat's management has a fiduciary responsibility to try to maximize shareholder value.

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Is Red Hat in financial trouble?

Posted Feb 28, 2011 21:38 UTC (Mon) by daglwn (guest, #65432) [Link] (11 responses)

> And Red Hat's management has a fiduciary responsibility to try to maximize
> shareholder value.

And right there is the failing of U.S.-style capitalism. Fiduciary responsibility is the only relevant factor. Moral responsibility doesn't even enter the equation for management.

We are just seeing the beginning of what we're going to reap from this highly warped value system we've built.

Is Red Hat in financial trouble?

Posted Feb 28, 2011 22:01 UTC (Mon) by hp (guest, #5220) [Link] (2 responses)

I don't think there's a moral problem with Red Hat raising their margins. After all right now they have very low margins relative to the industry. Raising them would be good for a lot of people, investors (anyone with an S&P500 fund), employees, and even customers in some ways (higher-margin companies usually can do more innovation and are more stable).

Practically speaking, though, the question is how much they _can_ raise the margins and how quickly.

Is Red Hat in financial trouble?

Posted Feb 28, 2011 22:19 UTC (Mon) by boog (subscriber, #30882) [Link] (1 responses)

A few responses to the discussion on business and ethics:

- a FOSS business is expected to have low margins;

- monopolies have high margins that should be undercut by FOSS companies;

- nothing is stopping RH taking a long-term view of shareholder value (growing the cake not their slice); does that charming American law mention a time limit?

As a non-FOSS example of the last point, take Apple, who happily and repeatedly make their own top-selling products obsolete with their breakneck pace of development; many companies really struggle not to rest on their laurels in that kind of situation.

Debian seems to be the tortoise in this race.

Is Red Hat in financial trouble?

Posted Feb 28, 2011 22:31 UTC (Mon) by hp (guest, #5220) [Link]

Not sure I agree that a FOSS business is expected to have low margins. The stock market does not currently expect Red Hat to have low margins. Investors appear to believe they will have high margins. Maybe there's an alternative explanation for the stock price, but in my opinion it's based on hopes for either an acquisition or higher margins.

I do agree that high margins will involve some competitive advantage, but I don't think it has to go so far as a monopoly. My view is that "monopolistic competition" as an economics textbook would say is a good balance between interests of the company and the consumer. These are the Cokes and Wrigleys, where they can't charge infinite amounts for sugar water and gum, but they do have some pricing power. Bob Young's vision for Red Hat in 1998 was a story about Heinz.

I think most people would say that management is supposed to focus on long-term value. Stocks are normally valued assuming perpetual duration.

But it's context-dependent; if a manager thinks the best outcome for shareholders is to liquidate the company and give them their money back, they're also supposed to do that. Some stocks obviously will not have perpetual duration.

In practice managers can do pretty much whatever they want, since there's no way to prove in court that such-and-such complex judgment was wrong. But managers who don't have investor confidence may not last very long.

If you were Red Hat management, you can't come out and say "oh, we'll have bad margins." The stock price would crater. In an interview a while ago, Red Hat's CEO said something like he'd compromised with analysts and agreed to increase margins 1% per year.

moral responsibility

Posted Feb 28, 2011 22:17 UTC (Mon) by dbruce (guest, #57948) [Link] (4 responses)

I don't think it is so black-and-white "money vs. morals". Red Hat's long term business plan and viability has apparently had everything to do with being a good FOSS citizen, "moral" if you will. So in the long run, it may be essential to the "fiduciary responsibility" to behave in a way that doesn't piss off the free software community.

Short term, sure, all the time we see companies doing dubious things to make the quarterly reports match up to market expectations. "Fiduciary responsibility" gets used as an excuse for almost any kind of trickery, but it doesn't mean the whole idea of investor-owned business is wrong.

Put it this way, if investors are in it for the long run, they are going to want management to do things that will win customers and keep them loyal for many years.

moral responsibility

Posted Mar 1, 2011 3:13 UTC (Tue) by allesfresser (subscriber, #216) [Link] (3 responses)

>if investors are in it for the long run

And therein lies the problem: most investors are not it in for the long run--that would require that they actually care about what the company does and why it does it. They are looking for essentially pump-and-dump results. When investors don't actually care about the company or its products, but only what money they can get out of it, it's not investing, but sociopathic gambling.

moral responsibility

Posted Mar 1, 2011 11:54 UTC (Tue) by dbruce (guest, #57948) [Link] (2 responses)

"And therein lies the problem: most investors are not it in for the long run-They are looking for essentially pump-and-dump results."

Do you have any data on that? My understanding is that the largest chunk of money in the stock market gets there via mutual funds. I don't think the typical fund manager has a "pump-and-dump" strategy. I know there is a popular image of the stock market as a place for wheeler-dealer day traders, and a lot of that activity certainly exists, but I thought that the bulk of stock investment actually is long-term buy-and-hold.

moral responsibility

Posted Mar 1, 2011 13:34 UTC (Tue) by nivola (guest, #5662) [Link] (1 responses)

Average stock hold time: 22 seconds.

Stock markets have changed pretty radically in the last 30 years, and not for the better. Hudson is talking about US markets here, but it's a similar story in Europe and elsewhere.

fishy statistics warning

Posted Mar 1, 2011 17:18 UTC (Tue) by jku (subscriber, #42379) [Link]

That figure is probably bogus and in any case not necessarily relevant: High frequency traders may do massive amounts of trades per day but large amounts of stock is still owned by long term investors. Trading the same stock thousands of times per day doesn't magically move the long term investments into the market.

It seems that the real mean duration of holding is still measured in months.

Is Red Hat in financial trouble?

Posted Mar 1, 2011 3:42 UTC (Tue) by tialaramex (subscriber, #21167) [Link] (1 responses)

Strictly speaking they're responsible for everything they sign up for. If a company says it's going to make boats and profit from that then yes, you can sue because the board made a decision that needlessly trims profits ("let's not charge Old Bill full price for these materials, he's a nice fellow") but you can also sue them for making a decision that interferes with the boat-building goal ("I don't even like boats, let's sell icecream")

The existence of the stock market does encourage some people to buy and sell stocks without knowing anything about the company (perhaps not even the name, the ticker symbol is enough to buy and sell) but the lack of interest by investors in non-financial goals is a failing of the investors and not of the businesses. In my experience the largest fraction of companies have a clear purpose stated in their paperwork, and many have a purpose that a layman would instantly understand like "sell people coffee" or "build skyscrapers" and thus investors do have the information to make ethical decisions if they choose to do so.

Red Hat, I think, says it makes Free Software operating systems (I won't swear what terms they use exactly). It cannot become a used furniture store without going through a process to change the paperwork or risking a lawsuit by investors. Until it does that, you can expect that producing Free Software will be a goal balanced with making money to keep the financial people happy. From time to time that will mean we don't get what we want, and we don't have to be happy about that (I think this change was stupid) but we shouldn't think its the end of the world.

Is Red Hat in financial trouble?

Posted Mar 1, 2011 16:12 UTC (Tue) by mpr22 (subscriber, #60784) [Link]

My understanding is that in England, the purpose of a company limited by shares is habitually stated in its paperwork to be "carrying out business". This avoids paperwork-wrangling when you decide that you'd like to carry out a kind of business you hadn't initially considered.

Is Red Hat in financial trouble?

Posted Mar 1, 2011 7:05 UTC (Tue) by paulj (subscriber, #341) [Link]

Moral responsibility can enter into things, if a company's constitutional documents say they should. Any shareholders who buy in can then not complain if the financial position is not maximised because of greater moral considerations.

Is Red Hat in financial trouble?

Posted Mar 1, 2011 5:16 UTC (Tue) by yuhong (guest, #57183) [Link]

FYI, see this: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1013744