A Banker’s View: IBM Buys Red Hat

By Chris Legg
Chris is a partner and Senior Managing Director at Progress Partners; He lives in Cambridge, MA, and is based in Boston.

November 2, 2018 ? Few developments will prove more impactful to the global technology M&A landscape than IBM’s October 28th announcement. From its Armonk, NY headquarters, IBM announced its acquisition of Linux specialist Red Hat in a blockbuster $34 billion transaction. Beyond the deal’s obvious size importance, the transaction provides valuable insight on the current state of the technology M&A environment and serves as a case study on how bankers are generating value for clients. With this, IBM CEO Ginni Rometty, has made her bet on her legacy.

The deal is first worth noting for its size. The ~$34 billion implied enterprise value IBM will pay for Red Hat, equating to $190 per share, ranks the transaction as the third-largest in U.S. tech history, IBM’s largest deal ever, and the largest ever acquisition of a software company. Only 2016’s $67 billion Dell-EMC merger and 2000’s $41 billion JDS Uniphase’s-SDL acquisition register as larger U.S. tech deals.

As a banker evaluating this from IBM’s perspective, Red Hat fits neatly into their shift away from servers and mainframes and towards recurring revenue software and service offerings. Red Hat was founded in 1993 and profitably generated $2.4 billion in revenue last year by charging fees for quality control, tools, and technical support surrounding open-source Linux software. With Linux serving as the preferred operating system for cloud computing, IBM sees the combination of the two companies as bolstering its joint standing in the corporate cloud market. Red Hat will operate as a “distinct unit” within IBM’s cloud team and will make IBM the world’s “#1 hybrid cloud provider,” according to Rometty. For the new IBM, the potential is huge. As of today, according to Rometty, 80% of business workflows have no yet transitioned to the cloud. In the acquisition press release, IBM marks itself as “the #1 hybrid cloud provider in an emerging $1 trillion growth market” as a result of the transaction.

From Red Hat’s perspective, the deal comes at an opportune time with the tech industry betting on open source software in a big way recently. Microsoft recently completed its $7.5 billion acquisition of GitHub, the software collaboration juggernaut and joined the Open Invention Network to help the open source movement protect itself from patent attacks. Meanwhile, salesforce.com and Cloudera placed their bets on the open source space with their $6.8 billion acquisition of MuleSoft and $2.1 billion acquisition of Hortonworks, respectively. Harnessing this momentum, Red Hat was able to command 9.4x next twelve month revenue and 34.0x next twelve months EBITDA multiples. The $190 per share price tag IBM is paying represents a ~62% premium to where shares finished on Friday, October 26.

For both IBM and Red Hat the transaction appears valuable in multiple respects. With global technology M&A trending for an approximately 50% year-over-year increase in 2018, companies are turning to bankers in near-unprecedented numbers to harness prevailing market forces and extract maximum value. This is a good deal for both sides. On a personal note, I am happy for Jim Whitehurst, my former classmate and CEO of Red Hat.

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