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IBM + Red Hat: Is This Cloud Acquisition a Winner?

IBM + Red Hat: Is This Cloud Acquisition a Winner?

Mac Greer: IBM making a big deal. On Sunday, IBM agreeing to buy Red Hat for
$33 billion or $190 in cash per share. That’s a 63% premium to
where Red Hat closed on Friday. That sounds like a lot, right? Emily Flippen: It is.
Jason Moser: It sounds like a lot. Greer: Not bad. IBM CEO Ginni Rometty says
the deal is all about, “resetting the cloud landscape.” Emily, I want to get into that here in a minute. The press release announcing the deal describes
Red Hat as “the world’s leading provider of open source cloud software.” When you look at the deal, shares
of Red Hat up around 47% today. IBM, down a little. A good deal for IBM?
Flippen: I think it’s a necessary deal for IBM. It’s an interesting deal for Red Hat. For a little fun fact, this is actually the
third largest deal in the U.S. history for tech. Greer: That’s kind of fun.
Flippen: It’s a fun fact. That is to say that, you’ll notice that Red
Hat shares are not exactly at that $190 price. That’s attributable to the fact that this
will need regulatory and shareholder approval before it moves forward.
I would expect that to happen. It’s an exciting deal for IBM. IBM has been posting really
stagnant growth over the past few years. They needed to do something. They were losing out horribly to competitors
like Amazon and Microsoft in this space. This acquisition for them is an attempt to control
every part of the cloud ecosystem for an enterprise. If you’re an enterprise, and you have a lot
of physical assets, in terms of traditional information storage, and you’re looking to
move towards a cloud environment, what they do is, they have an inter-between phase
where you’re operating in a hybrid cloud environment. This deal is going to allow IBM to get in
on the hybrid cloud environment space and help companies transition to that cloud
environment. They’re using Red Hat to do that. Moser: I think she hit the nail on the
head there. It was a necessary deal for IBM. We’ve been talking about IBM sort of just
sitting there doing nothing over the past decade, more or less, as every other tech company
we discus seems to be flying right past it. Typically, with big tech companies like this,
that are a little bit more based on legacy success, you have to go in there
and make a big deal like this. That’s why it’s such a premium,
I think. IBM really wants this. They don’t want Red Hat to go shopping around
and see if someone wants to up the ante a little bit. So, they’re paying a very heavy premium today.
It more than likely goes through. Perhaps there’s some scrutiny there. But when I looked at the two companies,
I think this really tells you everything you need to know. When you look at the companies, you note the
disparity in the research and development line item on their income statements. If you look at R&D as a percentage
of revenue, for Red Hat, it’s about 20%. They’re plowing a lot of the money they make
back into the business because they need to keep relevant and keep advancing. IBM’s around 7%, and they’re
basically doing that just to tread water. And that’s what they’ve
been doing for a long time now. To see them make a big deal like this isn’t
surprising. I think Red Hat’s a good business. The fundamentals are sound. Whether IBM actually does anything
really good with it remains to be seen. Greer: When you look at IBM the stock,
it hasn’t even been treading water. You look over the last five years. Emily,
we were talking about this before the show. Shares are down. You have lost
money on IBM over the last five years. That’s pretty tough to do in this market. Moser: Yeah, it had the reputation for the
longest time of, if you couldn’t really figure out what kind of market it was and how you
should be investing, you could always just buy shares of IBM and no one would hold that
against you because of its standing in the tech space. But obviously, tech has changed so much in
just the recent years, and IBM hasn’t really been spearheading that change. Greer: I want to talk more about this idea
of resetting the cloud landscape. IBM’s CEO says that big companies have
moved around 20% of their work to the cloud. Let’s just take that as our starting point. That leaves around 80% that all
of these different companies are competing for. IBM and Red Hat can go after that 80%.
But we’ve got a few competitors. Let’s just review some of the names in
that space. Amazon, Microsoft, and Alphabet. Flippen: What’s interesting about Red Hat
is they are focused on open-sourced platforms. When a person goes out
uses Red Hat as a provider, they’re not actually buying
any type of material software. All the code is already out there. If they wanted that, they could quite literally
go onto GitHub and copy and paste it. What they’re doing is, they’re buying
Red Hat support — the technology, the expertise that’s needed to implement that. It’s going to be
really interesting to see how they compete. You’ll notice that a lot of their
competitors actually use Red Hat. What IBM is trying to do is saying,
“Hey, we’re not going to be the big cloud provider that is Amazon Web Services. But, we can at least be the system
which Amazon Web Services is operating on.” Red Hat’s most widely-subscribed product is
Red Hat Enterprise Linux. It’s the operating system
that all this technology is running on. What they’re trying to do is get in on the
base level of that and try to be a player in the space without
necessarily directly competing. We mentioned earlier the culture around IBM,
how it’s been a slow growth company, not doing much in this space. I think that’s where
the controversy for this deal comes from. A lot of people see Red Hat as
an innovator, completely open-source. Any company that can make $2 billion selling
something that’s free is a good company in my book. Moser: [laughs] That’s a good point! Flippen: So, the opportunity there for a cultural
disillusion, as this company that’s been such an innovator, that’s been open-source, moves to
this conglomerate, this large, slow tech company, it could be a hard pill
to swallow for some employees. But IBM definitely needs the growth.
Greer: The old culture clash. We’ve heard that story before.
I think back to AOL and Time Warner. We will see how the deal shakes out.


It's not that IBM wouldn't have the skills or expertise to be innovative, however their corporate big heads primarily incentivise on cash cows and there is a lack of a startup / investment culture into new tech. So they miss out on trends and eventually end up beaten at their own game.

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