IBM is plunging $34 billion into its hybrid cloud, container and open source efforts, announcing over the weekend that it plans to acquire Red Hat for $190 per share in cash.
Red Hat will become part of IBM’s Hybrid Cloud business though as a “distinct unit.” Arvind Krishna, senior vice president of IBM’s Hybrid Cloud, said Red Hat would maintain its independence and neutrality, including commitments to its public cloud provider customers like Amazon Web Services (AWS), Microsoft Azure, and Google Cloud, and its open source commitments. IBM will also maintain Red Hat’s headquarters, facilities, brands, and practices.
Red Hat CEO Jim Whitehurst will join IBM’s senior management team and report to IBM President, CEO, and Chairman Ginni Rometty. Both boards have approved the deal with just Red Hat shareholders needing to sign off on the proposal.
Outside of the emphasis on hybrid cloud, Krishna touted a combined push around the Linux operating system, containers, and Kubernetes as key for enterprise customers. He also referenced a recent partnership to integrate IBM’s Cloud Private platform and middleware services with Red Hat’s OpenShift Container Platform. The combo allows customers to build and deploy containerized applications on a single, integrated container platform with a single view into enterprise data.
Paul Cormier, executive vice president and president for products and technologies at Red Hat, explained that the deal would not have any impact on its recently closed purchase of CoreOS. Red Hat earlier this month significantly updated its OpenShift platform with components from CoreOS.
Jay Lyman, principal analyst at 451 Research, said the deal was huge for IBM.
“IBM has been under pressure to make a move again to reverse its top-line compression and portray itself as a growth company again,” Lyman explained. “Even though IBM was already a major player in cloud, containers, and Kubernetes, the deal elevates its profile and market share in those areas.”
He added that it also provides IBM with deeper integration into other public cloud providers like AWS, Azure, and Google Cloud that were integral to Red Hat’s strategy and software.
For IBM, the deal also moves it down the stack closer to the developer community that is becoming more critical to building cloud native platforms. “Big Blue” has been known for basing its business and sales operations on its large-scale servers and presence in most large enterprises, but has lacked a more direct connection to those writing code.
This is somewhat similar to Microsoft’s recent $7.5 billion acquisition of GitHub. Microsoft has repeatedly stated that the deal gives it direct access to millions of developers in the GitHub ecosystem, and it has pledged to maintain that group’s freedoms.
Cormier said the deal will help boost Red Hat’s ability to provide a broader feature set to its customers. He noted that Red Hat was still a relatively small company and with IBM’s size it can now accelerate its push into the hybrid cloud and enterprise space.
“I think the issue for Red Hat has been to find the next major extension to their product line beyond Linux and Linux Virt,” noted Edwin Yuen, senior analyst at Enterprise Strategy Group, in an email “For a while, the play was for OpenStack, but the entire OpenStack adoption never hit what any of the larger OEMs thought they would. The key for Red Hat was OpenShift and container adoption, especially if on-premises/bare metal containers took off. If it will (and I think it will), then Red Hat would have been very well positioned for the future.”
IBM recently reported a 22 percent increase in cloud revenues for its third fiscal quarter, which it attributed to customers implementing hybrid cloud. “We are winning with our hybrid cloud value proposition in the marketplace,” said James Kavanaugh, SVP and chief financial officer at IBM, on an earnings call with investors.
IBM stated that Red Hat will accelerate its revenues, gross margins, and free cash flow within 12 months of closing. IBM will pay in both cash and debt and expects the deal to close in the second half of 2019.
And pay it will.
The $190 per share offer is a significant premium over the $117 per share Red Hat’s stock was sitting at prior to the IBM offer. In fact, Red Hat’s stock just last week had hit a new 52-week low of $115.31 per share.
It has been a sudden decline for Red Hat’s value as it has tumbled from a new 52-week high of $177.70 set in mid-June. That plunge began following the release of results for its first fiscal quarter of 2019. Most of those results came in at or above expectations, but lower billing caused some financial analysts to pull back on their expectations. The company’s stock took another hit following release of its fiscal Q2 numbers last month.
BMO Capital Markets analyst Keith Bachman wrote in a research note that perhaps Red Hat was seeing more billing headwinds than anticipated and figured now was as good a time as any to pull the (golden) parachute.
“Red Hat has stated that growth rates should improve in early to mid-[calendar year 2019], as the pipeline of renewals improves,” Bachman wrote. “While the premium is rich, we wonder if Red Hat has less conviction in the improving pipeline.”
The IBM offer has done wonders, of course, for Red Hat’s stock, which has surged more than 50 percent since the deal was put on the table to around $174 per share.
“It’s hard to argue it’s not a good exit for Red Hat given the valuation, but there is some sense that the industry is losing its open source software poster child,” added 451 Research’s Lyman.