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IBM just made the cloud-computing war far more interesting.
International Business Machines Corp. announced that it’s buying Red Hat Inc., one of the most successful pioneers of a software movement known as open source, which allows programming instructions to be accessible to anyone to view and alter.
Red Hat’s version of the Linux open-source software became widely used in companies’ computer servers, contributing to a shift in corporate technology standards away from the hulking mainframe computers sold by IBM and others. Red Hat became a major proponent of cloud computing, offering an alternative to tech giants such as Amazon and Microsoft that want to pitch customers on their own proprietary cloud-computing technologies.
On their own, IBM and Red Hat were destined to be perpetual laggards in the computing industry. IBM has been too tethered to its past to chart the future of technology. Red Hat was too small to compete with titans. But together, with this $33 billion deal, the duo may be able to plot a new course. While IBM is paying a rich price in the acquisition, the combined company can be a serious threat to Amazon, Microsoft and others that are reshaping the $2 trillion corporate computing industry.
The acquisition price reflects how hungry IBM is to change its standing as a company that’s having trouble growing and whose strategic direction is muddled. IBM is paying $190 a share for Red Hat, a premium of more than 60 percent to Red Hat’s most recent stock price. IBM’s offer values Red Hat at an eye-popping 51 times its estimated adjusted earnings for the next year, according to data compiled by Bloomberg. That’s a richer valuation than all but a tiny handful of fast-growing software companies.
The cash purchase price of more than $33 billion represents about two and a half years of IBM’s free cash flow at current levels. Yes, buying Red Hat does give IBM an asset with growing revenue and free cash flow, but it’s a big splurge for IBM CEO Ginni Rometty. Strategically, though, rolling the dice might be Rometty’s best play. On its own, IBM is destined to shrink in both revenue and technology relevance, despite the steady stream of company-generated hogwash about how much it is transforming into a technology leader. It is not.
Red Hat is too small to compete on same level as Amazon, Microsoft, Google, Oracle Corp. and other tech empires, and it has been considered too big to be an easy acquisition target for any of those powerhouses.
A combined IBM and Red Hat will need to make a strong case for why companies should bet on them rather than place their trust in Microsoft, Oracle or others also pressing the hybrid cloud approach.
It’s not an easy sell, but IBM and Red Hat certainly make a more compelling cloud-computing alternative as a combined force than they ever could on their own. Linking arms and fighting the tech giants together may be their best bet.
—Bloomberg
Shira Ovide is a Bloomberg Opinion columnist covering technology
. She previously was a reporter for the Wall Street Journal