IBM Buying Red Hat in $34B Mega-Deal to Beat Amazon, Google in Cloud

[Updated 10/29/18, 12:53 pm, with executives’ comments.] IBM has agreed to buy open-source software maker Red Hat in a $34 billion bet aimed at helping it win the cloud computing war against Amazon, Microsoft, and Google.

It’s one of the largest-ever U.S. tech acquisitions—the $67 billion Dell-EMC deal holds the top spot. Armonk, NY-based IBM (NYSE: IBM) has a reputation for making a lot of acquisitions, but this is the 107-year-old company’s largest by far, according to CNBC and Bloomberg. Its other notable deals in recent years include the $2.6 billion acquisition of Ann Arbor, MI-based Truven Health Analytics in 2016 and $1.7 billion purchase of Marlborough, MA-based business analytics and data warehousing firm Netezza in 2010.

Businesses use Red Hat’s software to build and manage infrastructure and applications for IT operations in the cloud. The 25-year-old company is perhaps best-known for its enterprise tools for Linux operating systems. Red Hat makes money primarily through selling subscriptions to software and providing training services that support its users. It brought in $2.9 billion in revenue last year and generated a $258.8 million profit.

One of the big questions is whether IBM is giving up too much to scoop up Red Hat and accelerate its cloud computing business. IBM’s stock price was down more than 3 percent Monday afternoon to just below $121 per share. [Updated share price.—Eds.]

IBM said it will pay $190 per share in cash for Raleigh, NC-based Red Hat (NYSE: RHT). The deal has a total enterprise value of about $34 billion, and IBM said it will fund the transaction with a combination of cash and debt. Moody’s Investors Service said Monday it will review IBM’s A1 credit rating for a possible downgrade.

Speaking on a Monday morning conference call with financial analysts, IBM CEO Ginni Rometty said the company does not need to sell any of its business units in order to fund the Red Hat acquisition. But she quickly added that she is not shy about acquiring businesses or divesting them when appropriate.

The Red Hat purchase is “all about growth” and “our ability to scale this everywhere,” Rometty said during the call from Red Hat’s headquarters in downtown Raleigh. “This is not a cost synergy case—this is a revenue growth case,” she added.

If the deal pans out, it could give Big Blue a leg up in the increasingly crucial area of enterprise cloud computing. Businesses have been moving their data storage and applications to cloud-based servers for years, and cloud computing companies say that shift is nowhere near complete.

“Most companies today are only 20 percent along their cloud journey, renting compute power to cut costs,” Rometty said in the press release announcing the deal. “The next 80 percent is about unlocking real business value and driving growth.”

That effort will require moving business applications to “hybrid cloud” environments, meaning a mix of cloud-based systems that businesses operate privately in-house and “public” cloud systems managed by a vendor, Rometty said in the press release. The cloud computing shift will also involve “extracting more data” and using cloud technologies to enhance all business operations, from supply chains to sales, she added.

Red Hat has said its competitors include Microsoft (NASDAQ: MSFT), Oracle (NYSE: ORCL), Amazon (NASDAQ: AMZN), Google (NASDAQ: GOOGL), and Pivotal Software (NYSE: PVTL), which raised $555 million in an initial public offering in April. Red Hat also competes with IBM in some areas, although the two companies also have a long history of forming partnerships.

Red Hat CEO Jim Whitehurst said during the conference call that joining forces with IBM is about addressing the needs of customers as they move more of their work into the hybrid cloud. Although both IBM and Red Hat have hybrid cloud offerings, Whitehurst claimed those products do not overlap. By joining forces, the two companies can provide customers a more complete offering, he said.

Whitehurst also said that Red Hat’s partners, which include Amazon and Microsoft, “are thrilled” by the deal. (It’s not unusual for cloud services companies to try and find ways to partner with their competitors—San Antonio, TX-based Rackspace has taken this approach as well.)

“This is about growing the pie, not about moving around the deck chairs in a static environment,” Whitehurst said of the sale to IBM.

The deal is expected to close in the second half of 2019. It has been approved by the boards of both companies, but still requires the approval of Red Hat shareholders and regulators.

IBM said Red Hat will operate as a “distinct unit” within IBM’s hybrid cloud business. Rometty, who planned to speak to Red Hat’s employees today, said during the call with analysts that IBM will keep Red Hat’s nearly 12,000 employees and more than 95 offices around the world.

[Xconomy editor Frank Vinluan contributed to this report.]

Jeff Engel is a senior editor at Xconomy. Email: jengel@xconomy.com Follow @JeffEngelXcon

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