IBM Makes “Company Saving” Purchase

Here Are the Key Takeaways from the Merger Along with the Market’s Response

IBM agreed to pay $33.4 billion, or $190 per share, for Raleigh-based Red Hat Inc. According to our analysts, that’s a 63% premium over Red Hat’s closing price on Friday, which was $116.68 per share. By our estimates, the price is the equivalent of 2.5 years’ worth of IBMs cash flow, or 10 times their sales.

And that kind of debt load did not go over so well with shareholders, as share prices of IBM fell 4.25% by Monday’s close.

For IBM, however, the rewards of a strategic play for cloud service dominance outweighs the debt burden.  The company’s only revenue growth in recent months has been from its legacy mainframe business services, which has concerned investors. Intel (another cloud services provider) share prices have declined 12% for the year, much of those losses occurring in Q3, when stock prices fell 8%.

Intel is down almost 40% from its highs in 2013. 

Red Hat is also down from its highs in June of this year, falling some 28% over the past 6 months on fears that competitors were eating its lunch. The merger sent shares soaring over 40% on Monday, however, bringing stock prices within striking distance of its June highs.

“It’s a Game Changer. It Changes Everything About the Cloud Market.”

IBM’s chairman and CEO, Ginni Rometty, was talking up the deal all through Sunday and into Monday, claiming it’d allow IBM to compete directly with the likes of Amazon and Microsoft for the lucrative cloud service market. She noted that Red Hat would become a unit of IBM’s Hybrid Cloud team.

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IBM’s Hybrid Cloud—which has been a major imperative for the company—has seen mixed results prior to the merger. In Q3, cloud revenues for IBM grew to $4.5 billion. That’s an increase of 10% from the previous quarter, but slower than the 20% increase in Q2. Rometty hopes that Red Hat’s expertise combined with IBMs resources will lead to substantial gains within this sector.

“We will scale what Red Hat has deeply into many more enterprises than they’re able to get to,” said Rometty during a phone interview with Bloomberg.

Financing and advising for the merger went to Goldman Sachs Group and JP Morgan & Chase Co, both of whom assisted IBM an and Red Hat throughout the process. “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,” said Jamie Dimon, CEO of JPMorgan, in a statement.

IBM Needed to Do Something Drastic to Stay Relevant, And Their Bet May Pay Off

IBM has been trying to break into the cloud market for some time now with only marginal success. Cynics claim the acquisition comes as a last resort, with IBM throwing in the towel and buying what they couldn’t make themselves.

That may be so, but if Red Hat gives IBM another lease on life, it hardly matters that their initial attempts failed. Right now, the company needs to think about its future. Bringing in new ideas and new blood may be just the way to go about it.

There have been some bad tech mergers over the last two decades. It’s impossible to tell yet whether this will be one of them. Still, though, there’s reason to be optimistic about the merger’s chances of success. Red Hat could benefit greatly from IBM’s Watson AI and large clientele base. Meanwhile, Red Hat’s cloud experience may be the impetus that drives IBM out of its years’ long rut and into a profitable future.

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