International Business Machines Corp. (IBM), Microsoft Corporation (MSFT): Why Did Wall Street Let Red Hat, Inc. (RHT) Off the Hook?

When Red Hat, Inc. (NYSE:RHT) reported earnings on Wednesday night, you’d have thought that the company was badly broken. Shares plunged as much as 13.4% in the first ten minutes after the release.

It seemed like an open-and-shut case. The open source software veteran reported $348 million in fourth-quarter sales, while analysts had expected $349 million. This may not sound like a huge miss, but Red Hat, Inc. (NYSE:RHT) has a habit of exceeding revenue targets by a fair margin.

So, never you mind that adjusted earnings of $0.36 per share crushed Wall Street’s $0.30 targets — time to panic and sell! Demand for Red Hat’s products and services must be falling through the basement floor.

Right?

This fedora-sporting shadow is becoming a familiar sight in data centers everywhere; 90% percent of Fortune 500 companies employ Red Hat systems today.

Not so fast!
As you might have guessed from Red Hat’s bounce back to stronger share prices on Thursday, the real story isn’t quite that simple — or that gloomy.

The stock ended up 0.9% higher on Thursday, the previous night’s sudden crash all but forgotten. Moreover, the after-hours plunge was paired with fairly impressive trading volume, but the climb back to positive territory came amid nearly four times the average volume. There’s real conviction behind the upside move here.

How did Red Hat, Inc. (NYSE:RHT) pull off this magic trick? It’s a story of conservative accounting and more multi-year, million-dollar contracts.

Red Hat, Inc. (NYSE:RHT) landed a record number of $5 million deals this quarter, and also broke the high-water mark for $10 million contracts. At the same time, large customers are warming up to the idea of breaking multi-million dollar contracts into several annual payments. That way, a substantial one-time cost turns into a bite-sized line item in the budget that’s easier to explain to upper management, investors, and other stakeholders.

The company still gives its major customers the option to pay down large agreements all at once, but has no incentive to force it. Recording revenue early so you can sit on a swelling bank account with disappearingly small interest returns doesn’t make CEO Jim Whitehurst excited. So, why not break these deals up, leaving customers to pay for multi-year licenses on a multi-year payment plan?

When you do that, you can’t record all your order bookings right away. Red Hat’s billings are growing right alongside recorded revenues, and the off-balance-sheet order backlog expands even faster. This is the part that caught investors by surprise: Red Hat’s long-term visibility and solid orders are growing faster than the simple revenue figure seems to imply.