Oracle of Omaha Takes Massive Position in Red Hat Inc
Berkshire Hathaway Inc. (NYSE:BRK.A, NYSE:BRK.B) is run by legendary billionaire investor Warren Buffett, known as the “Oracle of Omaha.” Wall Street always looks forward to seeing what’s in Buffett’s quarterly 13F filing.
A listing of all his holdings, Berkshire Hathaway’s 13F filing is a barometer of where Buffett—often called the greatest investor of all time—thinks the markets are heading.
What was most interesting in Berkshire Hathaway’s fourth-quarter 2018 13F filing was how quiet its buys and sells were. At the same time, it was interesting that Buffett dumped his entire $2.1-billion stake in Oracle Corporation (NYSE:ORCL), which he’d only held for one quarter, and snapped up $733.0 million in Red Hat Inc (NYSE:RHT).
Hawkish Buffett Takes Break During December Meltdown
Buffett has provided Wall Street with numerous investing morals to live by. One of his most famous sayings is: “Be fearful when others are greedy and greedy when others are fearful.”
This contrarian view cautions investing in stocks when they are overvalued, and to swoop in when investors, running for the exits, create excellent buying opportunities.
Most analysts were probably expecting to see Buffett make some big purchases in the fourth quarter, and for good reason; the markets reeled in early October and experienced a mini-meltdown in December.
In fact, it was the worst December to pound Wall Street since the Great Depression. 2018 was also the year that saw tech stocks end their nine-year winning streak. It was the perfect storm for Buffett’s buying mantra.
Except he didn’t really bite. This was despite Berkshire Hathaway having $100.0 billion in its arsenal. But that doesn’t mean Buffett’s fourth quarter was entirely dull. In it were two big tech surprises.
As mentioned earlier, Berkshire Hathaway ditched its entire stake in Oracle. This is curious because Berkshire only just purchased 41.4 million shares of Oracle in the third quarter. (Source: “Berkshire Hathaway 13F,” U.S. Securities and Exchange Commission, February 14, 2019.)
Why did Berkshire Hathaway even bother to dive into Oracle in the first place? It’s tough to say. The “Oracle of Omaha” has been vocal about his failure to invest early in cloud behemoths like Amazon.com, Inc. (NASDAQ:AMZN) and Alphabet Inc (NASDAQ:GOOG).
“I made the wrong decisions on Google and Amazon,” Buffett told investors at the 2018 Berkshire Hathaway annual shareholders meeting in May 2018. (Source: “Warren Buffett: I was wrong on Google and Amazon, Jeff Bezos achieved a business ‘miracle’,” CNBC, May 5, 2018.)
Buffett also noted that he underestimated the impact Amazon was having on the entire retail sector and the rapid advancements it has made with cloud computing.
“I’ve watched Amazon from the start. I think what Jeff Bezos has done is something close to a miracle … The problem is when I think something will be a miracle, I tend not to bet on it. It would have been far better obviously if I had some insights into certain businesses,” said Buffett. (Source: Ibid.)
Oracle (the company, not Buffett the man) was known for its on-site technology. Now, thanks to the Internet, Oracle is a major player in cloud-based technology.
Like the broader market, Oracle’s share price was volatile in the fourth quarter of 2018, tumbling almost nine percent in December. It’s been rising since January, though.
Oracle’s share price is now up about 17% year-to-date and has gone on to levels not seen since March 2018.
Aside from unloading Oracle in the fourth quarter, the other big tech surprise in Berkshire Hathaway’s fourth quarter was that it added a sizeable position (4.2 million shares) in Red Hat Inc.
Red Hat Inc
Raleigh, North Carolina-based Red Hat Inc is the world’s leading provider of enterprise open-source solutions. That means the code itself is free. Red Hat makes money from support, training, and professional services, not software licenses or subscriptions.
The company has more than 95 offices worldwide, in 35 countries, and counts more than 90% of the Fortune 500 as its customers. (Source: “About Us,” Red Hat Inc, last accessed February 20, 2018.)
This includes 100% of airlines in the Fortune Global 500, 100% of communication service providers in the Fortune Global 500, 100% of commercial banks in the Fortune Global 500, and 100% of U.S. executive departments.
While businesses around the world are adopting the cloud, Red Hat is busy dominating the “hybrid cloud.”
Standalone cloud technology prevents clouds from interacting with each other. Open hybrid cloud, which is a combination of one or more public and private clouds, bridges clouds, bringing interoperability, portability, and flexibility together. (Source: Ibid.)
|RHT Stock Information|
|Market Cap||$32.2 Billion|
|Shares Outstanding||176.8 Million|
|50-Day Moving Average||$176.74|
|200-Day Moving Average||$158.57|
(Source: “Red Hat, Inc. (RHT),” Yahoo! Finance, last accessed February 20, 2019.)
Red Hat Inc Reports Strong Q3 Results
On December 17, 2018, Red Hat announced its financial results for the third quarter of 2019 (ended November 30, 2018). Third-quarter revenue was up 13% year-over-year at $847.0 million, with subscription revenue advancing 13% to $741.0 million (accounting for 87% of total revenue). (Source: “Red Hat Reports Third Quarter Results for Fiscal Year 2019,” Red Hat Inc, December 17, 2018.)
Third-quarter operating income was down eight percent year-over-year at $109.0 million. Net income for the quarter was $94.0 million, or $0.51 per share, compared with third-quarter 2018 net income of $102.0 million, or $0.55 per share.
At the end of the third quarter, Red Hat had a total deferred revenue balance of $2.5 billion, a 20% increase year-over-year. On a constant-currency basis, total deferred revenue would have been up 23%.
Executive Vice President and CFO Eric Shander said:
In Q3, we closed 100 deals over $1 million and delivered double digit total revenue growth of 13% year-over-year, or 15% in constant currency and deferred revenue growth of 20% year-over-year, or 23% in constant currency despite continued foreign exchange volatility. Moreover, our total backlog grew 22% year-over-year to approximately $3.5 billion…strong renewals of our largest deals also helped drive these results with all of our top 25 deals renewing at an upsell rate above 120%.
Despite the robust numbers, Red Hat did not provide guidance for fiscal-year 2019 because of its pending transaction with International Business Machines Corporation (NYSE:IBM), nicknamed “Big Blue.”
IBM to Acquire Red Hat
On October 28, Red Hat announced that IBM will be acquiring all of the issued and outstanding common shares of the company for $190.00 per share, putting the deal at approximately $34.0 billion and making it the largest software deal in history. (Source: “IBM To Acquire Red Hat, Completely Changing The Cloud Landscape And Becoming World’s #1 Hybrid Cloud Provider,” Red Hat Inc, October 28, 2018.)
The deal, which is subject to regulatory approvals and other conditions, is expected to close in the second half of 2019.
Upon the closing of the acquisition, Red Hat will join IBM’s Hybrid Cloud team as a distinct unit.
After the announcement, Red Hat’s share price soared to an intra-day high of $174.48 before closing the day up 45.3% at $169.63. That was $21.00 shy of the $190.00 acquisition price. Since then, the company’s share price has been inching higher.
Chart courtesy of StockCharts.com
There are a few questions surrounding the acquisition. Namely, what’s in it for IBM and its long-suffering shareholders?
Analysts have noted that IBM’s cloud and “Watson” AI segments are not growing as quickly as they would like. Buying Red Hat would certainly change that landscape. But again, Red Hat’s software is open source.
What is IBM paying for, then? The team at Red Hat? That’s a lot of money for a “commodity” that could, in theory, leave.
Some analysts also think there could be a bidding war for Red Hat. That seems unlikely since IBM offered a 62% premium on the company’s share price. And $34.0 billion for a company that posts annual revenue of around $2.9 billion is a lot.
Moreover, since the announced acquisition, the company’s share price hasn’t even touched the acquisition price. That’s not a lot of incentive for another company to offer more for Red Hat.
Will Big Blue’s acquisition of Big Red go through? There are concerns that the merger of IBM and Red Hat may face hurdles.
But if it helps grow revenue, perhaps the eye-watering acquisition price will be worth it for IBM—and for Warren Buffett and Berkshire Hathaway investors.
Only time will tell; the latter part of 2019 is still a long ways away.