RALEIGH – An analyst who has been very friendly to Red Hat in the past slammed the Hatters with a dose of new reality on Monday.

Before the markets opened, Jefferies & Company’s Katherine Egbert slashed her price target for Red Hat (NYSE: RHT) stock four bucks a share to $19.

Egbert also downgraded Red Hat to “hold” from “buy.”

And server virtualization is a primary reason.

As more companies jump on the virtualization bandwagon, this relatively new phenomenon means less need for Red Hat Linux-equipped servers, Egbert noted. Virtualization enables multiple operating systems to be run on the same piece of hardware.

Interestingly, Egbert noted that the virtualization rage is also proving to be beneficial for Microsoft.

Noted Egbert in a sentence sure to rattle Microsoft competitors: “The last 3 quarterly reports from IDC show Windows server growth rates equal to or just below Linux for the first time in 10 years.”

Wow.

The Skinny wrote recently about good news coming Red Hat’s way, such as a CIO survey that debunked much of the criticism about service coming from Oracle’s Larry Ellison. But Jefferies sees many clouds on the horizons.

While she isn’t expecting any bad news when Red Hat reports its latest quarterly earnings next week, Jefferies is warning that Red Hat Enterprise Linux faces tougher sells.

“Virtualization enables difference OSes to run on a single server, negating the need for dedicated Linux servers to run Unix apps, and robbing Linux of OEM market share,” Egbert wrote along with colleague Eric Bukovinsky. “Red Hat is likely to continue to diversify away from [Red Hat Enterprise Linux].”

Explaining further the impact of virtualization, Egbert noted that the technology offers “a greater opportunity to reduce costs.”

In ominous news for Red Hat shareholders, Egbert added: “New servers are also increasingly shipped with Windows + VMware [virtualization software], further robbing Linux of marketshare at the OEM level.”

To counter this market move, Red Hat is likely to further diversify away from reliance on Linux with more deals such as the acquisition of Atlanta-based JBoss, Egbert added.

Despite the broadside, Red Hat shares were little affected in trading Monday. As for today and in the near future, who knows what the reality on the Street will be.