IBM said on 28 October had agreed to acquire US software company Red Hat for $34 billion, including debt, as it seeks to diversify its technology hardware and consulting business into higher-margin products and services.
The transaction is by far IBM’s biggest acquisition. It underscores IBM chief executive Ginni Rometty’sefforts to expand the company’s subscription-based software offerings, as it faces slowing software sales and waning demand for mainframe servers.
IBM, which has a market capitalization of $114 billion, will pay $190 per share in cash for Red Hat, a 63 percent premium to 26 October’s closing share price.
Founded in 1993, Red Hat specializes in Linux operating systems, the most popular type of open-source software, which was developed as an alternative to proprietary software made by Microsoft.
Headquartered in Raleigh, North Carolina, Red Hat charges fees to its corporate customers for custom features, maintenance and technical support, offering IBM a lucrative source of subscription revenue.
Red Hat is one of the very few companies in the cloud computing sector that has both revenue growth and free cash flow, Rometty, who has been IBM’s CEO since 2012, said in an interview with Reuters.
“This acquisition we are clearly doing for growth synergies. This is not about cost synergies at all,” Rometty said in the interview.
The acquisition illustrates how older technology companies are turning to dealmaking to gain scale and fend off competition, especially in cloud computing, where customers using enterprise software are seeking to save money by consolidating their vendor relationships.
IBM is hoping the deal will help it catch up with Amazon, Alphabet and Microsoft in the rapidly growing cloud business. IBM shares have lost almost a third of their value in the past five years, while Red Hat shares are up 170 percent over the same period.
“This deal represents the culmination of IBM’s existing partnership with Red Hat, and, in our view, allows IBM to gain a highly strategic asset to advance its hybrid cloud initiatives,” Barclays analysts wrote in a research note.
They added that for the deal to work, it was important for IBM to uphold Red Hat’s neutrality when it came to operating platforms and maintain Red Hat’s open-source and multi-cloud position in the market.
IBM was founded in 1911 and is known in the technology industry as Big Blue, a reference to its once ubiquitous blue computers. It has faced years of revenue declines, as it transitions its legacy computer maker business into new technology products and services. Its recent initiatives have included artificial intelligence and business lines around Watson, named after the supercomputer it developed.
To be sure, IBM is no stranger to acquisitions. It acquired cloud infrastructure provider Softlayer in 2013 for $2 billion, and the Weather Channel’s data assets for more than $2 billion in 2015. It also acquired Canadian business software maker Cognos in 2008 for $5 billion.
Other big technology companies have also recently sought to reinvent themselves through acquisitions. Microsoft this year acquired open source software platform GitHub for $7.5 billion; chip maker Broadcom Inc agreed to acquire software maker CA Inc for nearly $19 billion; and Adobe Inc agreed to acquire marketing software maker Marketo for $5 billion.
One of IBM’s main competitors, Dell Technologies Inc, made a big bet on software and cloud computing two years ago, when it acquired data storage company EMC for $67 billion. As part of that deal, Dell inherited an 82 percent stake in virtualization software company VMware Inc.
The deal between IBM and Red Hat is expected to close in the second half of 2019. IBM said it planned to suspend its share repurchase program in 2020 and 2021 to help pay for the deal.
IBM said Red Hat would continue to be led by Red Hat CEO Jim Whitehurst and Red Hat’s current management team. It intends to maintain Red Hat’s headquarters, facilities, brands and practices.
Lazard Ltd offered financial advice to IBM, alongside Goldman Sachs Group Inc and JPMorgan Chase & Co, which also provided financing for the deal. Paul, Weiss, Rifkind, Wharton & Garrison LLP provided legal advice to IBM.
Guggenheim Partners LLC and Morgan Stanley were financial advisers to Red Hat, while Skadden, Arps, Slate, Meagher & Flom LLP offered legal advice to the company on the deal.
“Knowing first-hand how important open, hybrid cloud technologies are to helping businesses unlock value, we see the power of bringing these two companies together, and are honored to advise IBM and commit financing for this transaction,” JPMorgan CEO Jamie Dimon said in a statement.
New York: IBM’s purchase of Red Hat Inc. is a $33 billion bid aimed at catapulting the company into the ranks of the top cloud software competitors. The cash deal, IBM’s biggest ever by far, boosts the 107-year-old computer-services giant’s credentials overnight in the fast-growing and lucrative cloud market — and gives it much-needed potential for real revenue growth. The company once synonymous with mainframe computing has been slow to adopt cloud-related technologies and has had to play catch-up to market leaders Amazon.com Inc. and Microsoft Corp. in offering computing and other software and services over the internet.
“The acquisition of Red Hat is a game-changer. It changes everything about the cloud market,” said Ginni Rometty, chairman and chief executive officer of International Business Machines Corp., in a statement Sunday.
IBM has seen revenue decline by almost a quarter since Rometty, 61, took the CEO role in 2012. While some of that has been from divestitures, most is from declining sales in existing hardware, software and services offerings, as the company has struggled to compete with younger technology companies. She has been trying to steer IBM toward more modern businesses, such as the cloud, artificial intelligence and security software with inconsistent results.
In its third-quarter earnings report, IBM disappointed investors who were seeking more progress in those areas after six years of declining sales that had only recently started to show gains. Still, the improvements had been coming largely from IBM’s legacy mainframe business, rather than its so-called strategic imperatives. Cloud revenue grew 10 percent in the period to $4.5 billion, but that was slower than the 20 percent expansion in the second quarter.
The Red Hat deal could signal to investors that IBM wasn’t as well positioned in cloud as it had been claiming, said Jim Suva, an analyst at Citigroup Research.
“We expect investor skepticism around the deal given IBM’s messaging that it is well underway in its transformation,” he said.
Investors have grown impatient. The stock is down 19 percent this year and 31 percent over the last five years, giving IBM a market value of $114 billion. Warren Buffett virtually gave up on IBM last year. His conglomerate, Berkshire Hathaway Inc., cut its stake in the company by 94 percent, while increasing its investment in Apple Inc.
The Red Hat deal represents an admission by Rometty that in-house growth wasn’t going to be enough to keep IBM from falling permanently behind in a market that is growing in importance and size.
Acquiring Red Hat makes IBM “a credible player in cloud now,” Bloomberg Intelligence analyst Anurag Rana said. “This gives them an asset that looks forward and not backwards.”
IBM will pay $190 a share in cash for Raleigh, North Carolina-based Red Hat, according to a statement from the companies Sunday, confirming an earlier Bloomberg News report. That’s a 63 percent premium over Red Hat’s closing price of $116.68 per share on Friday.
Rometty said IBM “paid a very fair price. This is a premium company. If you look underneath, this is strong revenue growth, strong profit strong free cash flow,” she said.
Revenue at Red Hat, which sells software and services based on the open-source Linux operating system, is expected to top $3 billion for the first time this year as the company’s Red Hat Enterprise Linux product attracts business from large customers. Last quarter the company reported a record 11 contracts valued at over $5 million each and 73 over $1 million, according to a note from JMP Securities analyst Greg McDowell.
At the same time, sales last quarter overall missed analysts’ expectations and the forecast for the current quarter also fell short, fueling concerns Red Hat may be losing deals to rivals and growth may be slowing. The company said at the time it believes the slowdown has “bottomed out.” Red Hat’s stock is down 28 percent over the past six months through Friday, according to data compiled by Bloomberg.
Armonk, New York-based IBM will continue to grow its dividend and neither company will cut jobs after the deal, Rometty said.
“This is an acquisition for revenue growth, this is not for cost synergies” she said.
JPMorgan Chase & Co. and Goldman Sachs Group Inc. and Lazard Ltd. advised IBM on the deal. Morgan Stanley and Guggenheim Partners were financial advisers to Red Hat, while Skadden Arps Slate Meagher & Flom provided legal advice.
“Knowing first-hand how important open, hybrid cloud technologies are to helping businesses unlock value, we see the power of bringing these two companies together,” JPMorgan CEO Jamie Dimon said in an emailed statement.
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