This Tiny Company Could Crush Yahoo And Google In One Critical Market

By Karen Canella
December 12, 2013

Talk of the National Security Administration's (NSA) snooping escapades emerged out of the shadows and into the international spotlight in July when former contractor Edward Snowden leaked the mass secret surveillance to the news.

Since then the media has been relatively quiet on the scandal.  But now a new Snowden snitch just published in the London-based Guardian newspaper has the United Nations scrambling in the name of "national security."

Once the dust settles, several high-profile companies could take a lot of blame and potential losses. But in the process one tiny company is poised to steal market share from the giants – and that could mean big gains for investors.

To refresh your memory about the July outing, Snowden said the NSA had tapped hundreds of millions of phone lines domestically and internationally, as well as fiber cables used for Internet communications.

Blue chip companies providing "public cloud" services like Amazon, Yahoo, Google and Microsoft -- whether knowingly or not -- were guilty by association.

In fact, by accessing the links that connect Yahoo and Google data centers worldwide, the NSA collected 181,280,466 new records over a 30-day period. This metadata revealed who sent or received e-mails and when, as well as texts, audio and video.

The breach of privacy sent foreign countries, corporations and individuals into a tizzy and rumblings spread throughout the cloud computing industry.

As a result, Information, Technology & Innovation Foundation (ITIF) estimates that U.S. public cloud providers could lose $21.5 billion to $35 billion over the next three years. The foundation later called these estimates "conservative."

Its survey also revealed that: "Ten percent of foreign companies using cloud computing services said they'd already cancelled a project with a U.S. cloud provider, and 56% said they'd be less likely to use U.S.-based providers."

In addition, 36% of U.S.-based respondents to a membership survey by the Cloud Security Alliance said that the NSA disclosures made it more difficult for them to do business outside of the U.S.

In fact, in mid-November, Cisco (Nasdaq: CSCO) blamed the NSA discoveries on a 12% drop in sales. The Financial Times reported that sales from Brazil and Russia sank 25% and 30%, respectively, taking overall sales down 10%.

With big name competitors taking a hit on credibility and profits, the door is open for one small company to sneak in and increase its market share.

Enter Red Hat (NYSE: RHT), a leading developer of Platform-as-a-Service-specific (PaaS) software for the cloud operating system capable of supporting public and private clouds.

PaaS is one of the fastest-growing areas in cloud computing today. Simply put, it allows a company to rent virtualized servers to run applications and process data on a cloud operating system.

According to TheInfoPro Wave 5 Cloud Computing Study, comprised of IT decision-makers in Europe and North America, the worldwide cloud market will grow at a 36% annual rate through 2016.

An impressive 35% of respondents (more than one-third) said developing an internal private cloud was their top cloud-related project. The reason is because a "private cloud" gives companies more control over the security of their files.

As more and more companies move away from using the public cloud -- a market dominated by blue chip tech companies -- Red Hat has a golden opportunity to steal market share and boost its profits from private cloud development. That alone is a compelling reason for investors to take a closer look at Red Hat.

Already a favorite among data centers, Red Hat has performed solidly for the past decade, growing revenue at a consistent pace. That shows up in its stock price, up 500% from $10 in 2005 to a high of $60 in April last year.

It has since been range-bound trading between $45 and $55. Second-quarter 2013 was up 16% year-over-year and net income increased $38 to $40 million.. And with quite a few new products in the marketplace and increased availability, I expect the forward looking numbers will be looking up.

Bottom line: This is a solid company in a growing industry with an opportunity to pick up business lost by its larger competitors. The question is when and what will propel Red Hat back to $60 and beyond. Certainly, increased demand for private cloud services could be the catalyst.

Action To Take--> Red Hat is currently trading at $46.77, not far from its 52-week low of $41.89. I like this entry point ahead of its third-quarter earnings report on Dec. 19.