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IBM
takes a big risk when buying
Red Hat
.
RHT 42.82%
Doing nothing would be more risky.
International Business Machines, the first major high-tech company, makes its largest acquisition in more than a century, with the purchase of Red Hat for $ 33 billion.
The cash deal, announced Sunday, represents about 29% of IBM's total market capitalization at last week's close and more than double the company's reported $ 14.7 billion cash balance.
As such, the deal will add significantly to IBM's debt load and will likely lower its credit rating, increasing borrowing costs. Toni Sacconaghi, of Bernstein, estimates that IBM's annual interest costs will increase by $ 1 billion a year.
In other words, an expensive operation that will not be immediately "transformational" in the jargon of negotiations. Red Hat's estimated $ 3.4 billion in revenue for the current year would add approximately 4% of IBM's total revenue.
That said, Red Hat brings a relatively high margin software business to stable IBM offerings. More importantly, Red Hat gives IBM a significant boost in the sale of hybrid cloud services to businesses. These services involve businesses that use a combination of public cloud services, such as Amazon Web Services, alongside their own private cloud networks. According to a Jefferies & Co. forecast, about 85% of companies should adopt a hybrid cloud approach.
Red Hat is a big bet of IBM in the right direction. It will, however, depend a lot on the integration, Red Hat also doing a lot with IBM's competitors.
According to IBM, Red Hat will be managed "as a separate unit," the current CEO, Jim Whitehurst, reporting directly to IBM's chief, Ginni Rometty, while maintaining its headquarters and practices. It is worth noting that VMware has already shown that such a model can work. This company has managed to maintain its independence through EMC and now Dell.
Nevertheless, IBM has never been successful in securing a contract of this size and, at more than nine times Red Hat's forward sales, the Red Hat offering implies a net premium even in the expensive sphere of the cloud.
But IBM had to do something different. Its revenues peaked in 2011, while free cash flow peaked a year later. IBM shares have been stalling Nasdaq for almost five years. Giants falling in technology have limited appeal, even for value investors.
The purchase of Red Hat should give Big Blue's cloud an indispensable lift.
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