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IBM Acquires Red Hat for $34B, Boosts Hybrid Cloud Platform

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International Business Machines Corporation IBM has completed the acquisition of Red Hat in a cash-and-stock deal valued at about $34 billion. The deal, which was announced in October 2018, is part of the company’s efforts to bolster Open Hybrid Architecture Initiative. Consequently, Red Hat shareholders will obtain $190.00 per share in cash.

The deal marks IBM’s largest acquisition ever and the combined company is likely to alter the dynamics of “the cloud market for business.” Specifically, IBM hopes to leverage Red Hat to help it become the world’s largest hybrid cloud platform provider.

The company anticipates Red Hat buyout to improve revenue growth by approximately at a CAGR of two points over a five-year period. IBM also anticipates Red Hat buy to aid it in sustaining robust dividend growth.

Red Hat offers open source software solutions that include operating system, virtualization, management, middleware, cloud, mobile and storage technologies. The company is a pioneer of the open source development model. The company is headquartered in Raleigh, NC.

Following the buyout, Red Hat will join IBM's Cloud and Cognitive Software segment and will function as a separate entity. Further, Red Hat will be led by its current CEO, Jim Whitehurst, who will join IBM's senior management team and report directly to IBM’s CEO, Ginni Rometty. Under IBM’s umbrella, Red Hat's headquarters, facilities, brands and practices will remain unaltered.

With the buyout, IBM intends to provide enterprises with market leading hybrid cloud platform enabling them to transfer their business applications seamlessly to the cloud.

Per IBM’s research, “80% of business workloads have yet to move to the cloud, held back by the proprietary nature of today's cloud market.” IBM intends to bridge the gap by enabling data portability and data security across multiple cloud platforms on the back of the buyout.

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Deal Details

IBM Cloud remains the key to winning back investors’ optimism regarding strength of the company’s business model. IBM’s cloud revenue as a percentage of total revenue has increased from 4% in 2013 to 25% in 2019.

In fact, in the first quarter 2019, cloud revenues surged 10% year over year. Cloud as-a-service revenue annual run rate was $2.1 billion. Revenues from cloud and data platforms increased 2% year over year.

We believe IBM’s attempt to bolster its hybrid cloud business is likely to pave the way for the company’s growth prospects. The company cloud revenue business surpassed $19 billion in the 12-month period.

Notably, the pioneer of the open source development model, Red Hat is leaving no stone unturned to expand its Red Hat Enterprise Linux (RHEL) customer base and exposure to hybrid cloud infrastructure. Red Hat noted that its total addressable market (TAM) is more than $66 billion in size, with significant exposure to Middleware, OS and Cloud management.

Red Hat’s OpenStack (uses RHEL to scale infrastructure across hybrid cloud) is a key catalyst. In fact, Red Hat reported revenues of $3.4 billion fiscal 2019, which increased 15% year over year, primarily driven by strong demand for hybrid cloud technology solutions and aggressive cross-selling.

Apart from the aforementioned factors, Red Hat’s expanding foothold across Asia Pacific is also anticipated to bolster IBM’s TAM post buyout.

What Investors’ Needs to Know?

The integration of Red Hat into IBM’s Hybrid Cloud is anticipated to be smooth, given both the companies allegiance to hybrid cloud and Linux. Moreover, both the companies have been partners for the past 20 years.

IBM and Red Hat will also continue to enhance Red Hat’s partnerships with the likes of notable cloud providers. These include Amazon’s AMZN Amazon Web Services, Microsoft’s MSFT Azure, Alibaba Cloud, and Alphabet’s Google Cloud, among others, apart from IBM Cloud.

The term “hybrid cloud” refers to any instance when public cloud and private cloud infrastructures are used simultaneously. Red Hat makes products that are designed to help customers manage multiple cloud platforms at once, so it seems an ideal match for IBM’s hybrid cloud ambitions.

With the closure of the deal, Red Hat is expected to expand business globally by leveraging IBM’s enterprise IT scale.

Balance Sheet & Cash Flow Details

IBM ended first-quarter 2019 with $18 billion in total cash and marketable securities compared with $11.9 billion in the previous quarter. Total debt (including current portion) was $49.9 billion, up from $45.8 million from the previous quarter.

The company reported cash flow from operations (excluding Global Financing receivables) of $4.8 billion and generated free cash flow of $1.7 billion in the quarter under review.

Moreover, the company returned $2.3 billion to its shareholders through dividends and share repurchases. The company returned more than $10.3 billion to its shareholders through dividends and share repurchases for the full year.

At the end of the year, the company had $2.4 billion remaining under current buyback authorization.

Bottom Line

We anticipate Red Hat’s addition to IBM Hybrid Cloud business to aid IBM to revive fortunes and pave the way for a robust and secure hybrid cloud infrastructure. Notably, the $34 billion deal is one of the notable software based acquisitions, surpassing Microsoft’s LinkedIn buy for $26.2 billion.

The deal is anticipated to pep up the cloud war since IBM’s Hybrid Cloud is poised well to gain from sturdy business model of Red Hat and its robust capabilities in providing hybrid cloud technology solutions.

Zacks Rank & Key Pick

IBM carries a Zacks Rank #3 (Hold).

A better-ranked stock in the broader technology sector is Dropbox, Inc. DBX, sporting a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Dropbox has a long-term earnings growth rate of 14.2%.

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