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IBM shrinks – IBM's revenue fell 2.1% in the last quarter – and its shares are down to 35% since today's CEO took over in early 2012.
So what better time to make the biggest acquisition in its history? That's what IBM October 29 is about paying $ 33 billion – a 63% premium over its close October 26th – to acquire open source software Red Hat is according to CNBC .
Red Hat offers services for its version of the open source (free of licensing costs) Linux software operates systems, middleware, storage, virtualization and administration tools. The company reports revenue through two categories: subscriptions, and training and services. America contributed about 64% of total revenue in fiscal policy 2018; Europe, the Middle East and Africa contributed 23%; and the Asia Pacific contributed 14%, according to Morningstar.
Red Hat is a growing and profitable company that shed a lot of money. Over the last five years, sales have increased by 17.1% to $ 2.92 billion, net revenues increased by 11.5% to $ 259 million and free cash flow grew almost 19% annual rate to $ 821 million, according to Morningstar . 19659036] Unfortunately, Red Hat has released in its last quarter. This was when the analysts' expectations for sales were missed, and the forecast for the current quarter also fell. Investors may have been concerned that Red Hat has lost agreements to rivals and that growth may be slowed down, according to Bloomberg, who noted that Red Hat shares are down 28% in the last six months to 26 October.
Is this agreement a good thing for IBM shareholders? Investors do not love this agreement – ship shares down 4% in early trading on 29 October. And I think it fails three of the four tests for successful acquisitions. (I have no financial interest in the securities mentioned in this post.)
To be fair, Red Hat competes in an attractive industry. However, the merged companies will not be better, IBM is overpaid and it will be difficult to integrate the two companies.
Industry Attention: Pass
Red Hats industry – Provides service and training for companies using open source software – is large, growing and profitable. As Red Hat's CEO, Jim Whitehurst, said in a SEC filing, "We believe our total addressable market will be $ 73 billion by 2021. If software is eating the world – and with digital transformation going on across industries, it's really – open source is the most important ingredient. "
In addition, IDC reported that IDC – with 32.7% of the server's operating system market in 2017 – just quit Microsoft. Within the Linux segment, IDC found that Red Hat Enterprise Linux adoption increased by almost 20% in 2017.
Better Off: Error
For sure, IBM and Red Hat appointed the appointment as a way to compete with Amazon and Microsoft in the so-called hybrid cloud. But IBM's approach to integrating acquisitions makes it very unlikely that the combined companies will be able to trade together to offer customers a better service and gain market share.
Firstly, IBM is known for its acquisitions to introduce internal product requirements – products must work for everyone and force customers to accept a lumpy bundle rather than a more focused and effective solution.
While IBM has been delivering Red Hat servers for years – and this deal will save IBM from paying Red Hat for it, it is still to see how well this deal will result in a cloud service that can increase IBM's loss 1.9 % share of cloud infrastructure revenues in 2017.
In addition, companies have purchased Red Hat products because it was considered a supplier neutral. Whitehurst, told CNBC that the combined company would be the biggest contributor to open source software. "We want [also] to remain clear because we want our customers to understand that Red Hat is coming in is a neutral selling."
However, as part of IBM, Whitehurst will have an insurmountable challenge to explain how Red Hat can be both neutral and not trying to make the acquisition profitable by encouraging customers to buy from IBM. This will be particularly difficult as he loses control of his product line and market strategy because of Big Blues bureaucracy.
Net Present Value Greater Than Nil: Error
By paying so much to Red Hat, it will take some heroic assumptions for this deal to generate a positive net present value. IBM has about 80 billion dollars in annual revenue, and Red Hat will add only 3.8 percent to Big Blues top line.
This is not much, but it may end up getting worse. After all, customers assume that Red Hat is owned by IBM. Companies that have previously purchased from Red Hat because it was perceived as neutral, can of course decide to switch to an independent rival.
Furthermore, Red Hat will only add 6% to IBM's free cash flow. To be sure there is no doubt that it is possible to take assumptions that would result in this 63% premium resulting in a positive present value. But I think IBM overpayer.
One of the main reasons why mergers fail is because the acquired company can not keep the best people in the acquired company. One factor that causes people to leave is a change in their culture. And Red Hat believes that maintaining his culture is critical to his success. According to its latest annual report
we believe that a critical contributor to our success has been our corporate culture, which we believe promotes innovation, creativity and cooperation. As our organization grows, our employees (including remote workers) and our resources become more globally spread and organizational structures become more complex and we can make it increasingly difficult to maintain these beneficial aspects of corporate culture. If we fail to maintain the corporate culture, it may be difficult to attract and retain motivated employees, continue to perform at the current level or implement our business strategy. As a result, our business, finances, operating results and cash flows can be adversely affected .
Will this culture survive to be acquired by IBM? Given the gap between IBM's actual culture and the one built by Thomas Watson, I would vote for no. But Rometty told Wall Street Journal that IBM intends to keep Red Hat's culture and brand.
To be fair, this is an outstanding deal for Red Hat shareholders who will undoubtedly enjoy the huge premium paid by IBM. Unfortunately, IBM's shareholders are probably disappointed that the agreement fails to pass the four tests for successful acquisitions.