A major piece of M&A news emerged from the technology
space this morning. Red Hat (RHT 169.56, +52.88, +45.32%), the world's largest provider of open source
cloud software, has agreed to be acquired by IBM (IBM 121.48, -3.31, -2.65%) for $190 per share in cash,
representing a total enterprise value of approximately $34 bln -- a whopping
63% premium from RHT's $116.68 closing price on Friday.
IBM sees the deal as a “game-changer” that will transform “everything about the cloud market,” according to IBM Chairman, President, and CEO Ginni Rometty, giving comments in a press release. She adds, “IBM will become the world's #1 hybrid cloud provider, offering companies the only open cloud platform that will unlock the full value of the cloud for their businesses.”
For Red Hat, combining with IBM increases the company’s scale and provides new access to resources and capabilities. This fresh position, which widens Red Hat’s audience, will enable it to accelerate the impact of open source as a basis for digital transformation. Red Hat insists that throughout the acquisition process, it will strive to preserve its culture as well as its commitment to delivering innovation in the open source space.
On the call, Rometty talked about factors motivating the deal, saying that for IBM, “it's all about resetting the cloud landscape” and moving to make IBM the undisputed leader in the hybrid cloud space, which IBM sees as a trillion-dollar business.
The process of migrating business workloads to the cloud among IBM’s cloud customers began with the cost-focused movement of the first, and perhaps the most easily-migrated, 10-20% of workload material to the cloud. Research indicates that up to 80% of business workloads still remain to be migrated, and to weather the obstacles involved in moving the other 80%, clients need what IBM and RHT will offer together. The average client has 1,000 applications and as many as 16 clouds. A main concern is that these other clouds are proprietary; clients now seek a secure and open approach to their cloud management, wanting to avoid lock-in and seeking the ability to concentrate operations on a single platform.
Why Red Hat? IBM has been supportive of the open source platform for 20 years. RHT does significant business with S&P 500 clients and also has a massive developer ecosystem, strong growth, and noteworthy cash generation. RHT is growing revenue at double digit rates. More importantly, it's a high value business, as shown by its strong margins and high cash flow. The deal also accelerates IBM's mix shift to higher value.
RHT expressed on the call that it's excited to join with IBM to drive hybrid cloud leadership and to leverage IBM’s scale to take opportunities to drive its own growth. Furthermore, Red Hat appreciates that IBM has a deep appreciation for RHT's open source values; this attitude agreement permits RHT to view this deal as, in ways, sponsoring a continuation of what it has already been doing and contributing to the expansion of its open source technology portfolio. The hybrid multi-cloud adoption that the two companies will pursue together in the interest of their clients will utilize the companies’ shared leadership in critical technologies such as Linux, multi-cloud management, and cloud management and automation.
IBM is trading lower on the deal; investors are perhaps concerned that the 63% premium is pretty rich. However, the high bid is probably intended to ward off other potential bidders. Also, Red Hat’s stock was trading at $177 as recently as mid-June, so the $190 price appears less lofty from that perspective. The tech sell-off has taken a bite out of RHT stock, and it's unlikely RHT would have agreed to a sale when its stock was in a downswing. Both parties know that the stock would have likely moved higher again when the overall market improved. Also, just based on RHT’s high margins and fairly unique premise and positioning, a big premium is not a huge surprise.
From a strategic perspective, the deal makes sense. The bulk of client business has yet to move to the cloud, held back by the proprietary nature of today's cloud market. With IBM's scale in combination with Red Hat’s share in the space of open source software providing, the two companies together seem well poised to tackle opportunities that acquisition presents. And this acquisition should provide a nice boost to IBM sales, which have been lagging in recent years. It will also be interesting to see if other bidders make an offer -- perhaps Amazon (AMZN), Salesforce (CRM), Microsoft (MSFT), Intel (INTC), Alphabet (GOOG), or Oracle (ORCL), for example.
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