IBM just bought Red Hat for a huge premium! or did it?

Disclaimer: Although I work for IBM, all the information for this article is from public domain & the views expressed here are my own and no way related to IBM’s internal information.

You must have read the news this weekend, IBM’s biggest acquisition , a $34 Billion buyout of Red Hat -> Buyout . As per this write-up -> WhenDoesTheDealclose, the deal will close in second half of 2019. That’s almost 9 months away from today. So let’s look at why I think IBM didn’t pay a huge premium as it currently looks.

At the current prices (before the deal was announced), with Red Hat trading at $120, the price IBM is paying, $190, looks to be an almost 60% premium. But wait, look at when the deal closes. Second Half 2019. So in effect, IBM will be paying $190 for each share of Red Hat sometime in July (or later) 2019. Looking at the revenue & profit growth at Red Hat, which is growing at ~25% per year, you would expect the Red Hat stock to be about 25% over it’s current value. That takes it to about $150 when the deal closes. So in effect, IBM is only paying $40 more, a ~25% premium over the price of Red Hat at the time of deal closing. Reasonable premium that what is advertised as of now.

The real benefit for Red Hat shouldn’t be looked at by the premium. The number of Sales personnel IBM has, Red Hat will grow far more than 25% after the acquisition. But again, I don’t think the merger should be looked at just from Red Hat perspective. The real growth as I see is in the Hybrid Cloud business for both IBM & Red Hat. If you talk to any CxO from a large organization, you will understand that they want to move to Cloud, but not entirely to Public Cloud, but a mix of Private/On-Prem & Public Cloud, thus a strong need for Hybrid Cloud.

Picking up some relevant lines from -> What Is Hybrid Cloud

  • Hybrid cloud is a cloud computing environment that uses a mix of on-premises, private cloud and third-party, public cloud services with orchestration between the two platforms. By allowing workloads to move between private and public clouds as computing needs and costs change, hybrid cloud gives businesses greater flexibility and more data deployment options.
  • Hybrid cloud computing enables an enterprise to deploy an on-premises private cloud to host sensitive or critical workloads, and use a third-party public cloud provider to host less-critical resources, such as test and development workloads.
  • The key to create a successful hybrid cloud is to select virtualization and cloud software layers (for private cloud) that are compatible with the desired public cloud, ensuring proper interoperability with that public cloud’s application programming interfaces (APIs) and services. The implementation of compatible software and services also enables instances to migrate seamlessly between private and public clouds.

Notice the words “seamless migration of software & services between private & public cloud”. This is where the combination of IBM & Red Hat will play a major role. This is what IBM will leverage Red Hat technology for, to provide seamless interoperability between customer’s on-premise environment, Private Cloud & that of IBM’s Public Cloud or any other vendor’s Public Cloud. And most of the large enterprises would prefer to work with 1 vendor, ensuring growth for combined IBM & Red Hat. This to me is the significant play, making the union a grand success.

So looking at the closing date, and with just 25% potential premium when the deal closes & the potential revenue growth, this looks like a great acquisition by IBM.