For IBM C
orp., the blockbuster acquisition of Red Hat Inc. is all about the cloud — many clouds, that is. IBM and Red Hat announced Sunday that the companies have reached a definitive agreement under which IBM will acquire all of the issued and outstanding common shares of Red Hat for $190 per share in cash and debt. This deal, which is the largest software acquisition ever by any firm, represents a total enterprise value of approximately $34 billion and a 63 percent premium over Red Hat’s pre-announcement closing stock price.
IBM is acquiring Red Hat to deepen its focus on helping enterprise developers to build containerized microservices to be deployed in private, public, hybrid and multiclouds. The acquisition, which is expected to close in the latter half of 2019, has been approved by the boards of directors of both companies but is still contingent on Red Hat shareholder approval, regulatory approvals and other customary closing conditions.
Big challenges
Though IBM is putting a brave face on the acquisition, it’s clear that Big Blue had to make a dramatic move to address lackluster revenue growth in its own public cloud offerings. Both firms face significant challenges positioning their hybrid cloud offerings in a market that is increasingly dominated by the top public-cloud providers. Owing to softness in its legacy mainframe and hardware businesses, IBM has been experiencing revenue declines for most of the past six years, including the most recent quarter, with its own public cloud revenues not growing fast enough to pick up the slack.
This acquisition comes just two weeks after IBM reported that its sales for its quarter ended Sept. 30 came in at $18.8 billion, down 2 percent from a year ago period, but flat when adjusted for currency fluctuations. The Technology Services & Cloud Platforms category, IBM’s largest segment that includes cloud infrastructure as well as technical support services and integration software, was down 2 percent, with $8.3 billion in revenue. IBM isn’t alone in finding itself increasingly stalling in public cloud momentum, a trend that has also bedeviled Oracle recently as customers flock instead to Amazon Web Services Inc.’s, Microsoft Corp.’s and Google LLC’s public cloud offerings.
In contrast, 25-year-old Red Hat continues to see revenue growth, though it has seen softening of late. In its fiscal 2018, which ended Feb. 28, Red Hat reported annual revenues up 21 percent from fiscal 2017, to $2.92 billion, and net income of $258.8 million for the year. In the financial analyst post-announcement call, IBM Chief Financial Officer James Kavanaugh cited Red Hat’s “attractive financial profile,” “strong backlog growth,” “high-value business” and “strong margin” as key factors that made this deal worthwhile.
These strengths also make Red Hat an attractive acquisition target for other public cloud providers — especially cash-rich AWS, Microsoft, and Google — any of whom could conceivably make Red Hat a more attractive offer before the deal is closed. It should be noted, however, that Red Hat’s most recent financials, though still growing, missed analyst targets on expected revenues and profits.
IBM intends to leverage Red Hat to become a primary enterprise on-ramp to the emerging multicloud. In a marketplace where enterprises are rapidly moving toward public clouds, the firms are betting that they can, according to IBM Chief Executive Ginni Rometty, help enterprises modernize, refactor and move the 80 to 90 percent of their workloads that aren’t currently in any cloud to a “robust hybrid environment” that spans public and private clouds.
Just as important, IBM/Red Hat plans to become an ongoing partner to help clients develop, secure and manage those cloud-native workloads, most of which involve containerized microservices orchestrated and managed across the multicloud on Kubernetes. To do so, IBM plans to invest in scaling its multicloud management solution portfolio, its integrated cloud-native computing stack and its professional services portfolio of combined Red Hat and IBM industry expertise.
Developer play
In essence, Red Hat is a developer play for IBM. Red Hat has built a substantial enterprise business serving developers with its open-source Linux distribution, OpenShift containerization platform, and other offerings. Red Hat, which has a substantial following in the cloud-native developer community, will benefit from IBM’s hybrid-cloud offerings, industry expertise, scale economies, and global marketing, sales, support and partner ecosystem. IBM plans to leverage Red Hat to cross-sell its Cloud Private solution stack. It also plans to integrate its IBM Analytic solutions with the Red Hat solution portfolio.
The acquisition comes just five months after the two companies unveiled a collaboration agreement targeting hybrid cloud opportunities through technology and services integration. IBM and Red Hat have been partners for more than 20 years, during which the firms have collaborated to develop and grow enterprise-grade Linux and in recent years bring enterprise Kubernetes and hybrid cloud solutions to customers. This acquisition will target hybrid cloud opportunities, leveraging IBM and Red Hat’s respective strengths in Linux, containers, Kubernetes, multicloud management and cloud management and automation.
IBM has promised continuity for Red Hat’s personnel, partners, and customers, as well as “independence and neutrality.” Red Hat will operate as a distinct unit within IBM’s Hybrid Cloud team. IBM intends to maintain Red Hat’s management team, headquarters, facilities, brands and practices. It will maintain Red Hat’s open-source community engagement, development culture, go-to-market strategy and product portfolio.
IBM will expand Red Hat’s widespread developer ecosystem and enhance Red Hat strategic partnerships with IBM’s public cloud competitors, including Amazon Web Services, Microsoft Azure, Google Cloud, and Alibaba, in addition to the IBM Cloud.
Going forward, it’s not clear when and how extensively IBM and Red Hat will converge their respective cloud-native computing offerings into a common stack. IBM has a vast solution portfolio that competes head-on with such open-source Red Hat offerings as JBoss, Ansible, OpenShift and OpenStack to address virtualization, containerization, DevOps and other cloud-native microservices requirements.
Signaling to the developer community its focus on Kubernetes as a core cloud-native developer platform, IBM “will prioritize the use of Red Hat technology across multiple clouds,” according to Arvind Krishna, senior vice president of IBM Hybrid Cloud. That’s easier said than done, which means that IBM’s and Red Hat’s respective customers and partners will wait on the edges of their seats for the deal to close and the actual solution shakeout to begin.
Likewise, there’s legitimate concern about how open the converged IBM/Red Hat solutions will be to third-party offerings from such heretofore Red Hat partners as AWS, Microsoft Azure, and Google Cloud platform. IBM already has many Linux-based solutions, ranging from servers to mainframe applications, and it’s very likely to couple these more tightly with Red Hat Enterprise Linux going forward. Will IBM provide development tooling that will be agnostic to those other public cloud providers’ respective hosted and premises-based Kubernetes distributions?
Defensive maneuver
And it’s not clear whether the converged one-throat-to-choke IBM/Red Hat cloud-native solution portfolio can blunt the momentum that the public cloud providers have gained in the enterprise market. Public cloud leader AWS has recently deepened its partnership with VMware to arm itself to compete more effectively in the hybrid cloud, while Microsoft continues to ride its solid hybrid-cloud offerings to impressive financial results in the enterprise. Many cloud-native developers have already committed to AWS and Microsoft as their core cloud-native platforms, with each of them providing credible multi-cloud offerings that blunt any advantages the converged IBM/Red Hat will offer in this regard.
Will this deal be the “game-changer” that Rometty promises? Hardly. It’s a defensive maneuver by both IBM and Red Hat to stay grounded in a fast-changing cloud business that’s converging on the three dominant public providers: AWS, Microsoft Azure, and Google Cloud Platform. IBM/Red Hat may remain a significant cloud-native development and deployment platform focused on multicloud, hybrid cloud and cloud-to-edge opportunities, but they’re not likely to stall the top-tier public cloud providers in enterprise customer adoption.
The IBM/Red Hat deal reminds me a bit of Sears acquiring Kmart in the hope of hedging against the decline of department stores and the challenge from online commerce providers. IBM, like Sears, is an old, venerable brand that has tried lots of tactics, including splashy acquisitions, to gain a new lease on life.
We know what has befallen Sears of late (and the Kmart near my house is going out of business). What’s noteworthy is that Amazon is the 800-pound gorilla in both of those distressed-old-brand scenarios.
