IBM Closes Acquisition of Red Hat for $34B

> Just from these numbers we can conclude that IBM is seeing some pretty significant synergies in the purchase that the market isn't.

Or there was basically very little chance that the acquisition wouldn't go through, and since we have known about it for months, it is already priced in the current stock value of IBM, so today's trading would be mostly unrelated and not representative of what investors think about the purchase.

Let's not confuse accounting earnings with cash flows. Red Hat is generating a decent amount of cash ~1B in cash from operations (difference from 433M mostly due to stock based comp and deferred revenue, common for software companies).

I didn't look into the details of the deal but IIRC $34B is the enterprise value, so it probably includes a refinancing of Red Hat's debt. RH had ~20M in interest last year, so you can take that off of the 700M.

So now we're talking about 680M in marginal interest expense on a firm with ~950M in pre-transaction free cash flow to equity. Not to mention RH's 65% top line growth in 2018, we'll see if that happens again. This transaction could be cash flow positive right off the bat.

Also Red Hat is operating at an ~18% ebitda margin (did not go looking for add backs), I'm assuming IBM can get that up.

Of course, it's easy to imagine IBM just torching all of Red Hat's top line... can't rule that out.

Red Hat net income is growing pretty consistently though [0].

With this price for debt, IBM could be cash-flow positive on this deal within a couple of years even without any big synergy, just by the simple effect of cumulated growth on (net) income.

[0] https://www.macrotrends.net/stocks/charts/RHT/red-hat/net-in...

The acquisition was most likely already priced in, but I think the synergy IBM is hoping for is that they are really really good at selling to the enterprise. They have one of the most successful enterprise technology sales teams in the world. I suspect that just making RedHat's enterprise sales more efficient will be enough to boost sales.

Red Hat is an incredibly valuable property that didn't sell aggressively enough.

Just by pushing on it's customer base, IBM will make alot of money on Red Hat, both with new business and blowing up legacy junk at IBM.

I like your analysis.

One thing that may be missing is how much money flows between them.

Free cash flow may be the more important metric for this purpose. I believe it is closer to $1B/year and presumably growing?

But IBM bought RH only because they believed that the company has growth ahead. If it grows a little more than 1% a year (which should be easy) that will be enough to break even. I think that was a smart move by IBM.

You need to add back income taxes of about $80M, so they are only $120M short. Interest expense is pre-tax.

Red Hat control and discretion and non-revenue generating properties now belong to IBM.

The purchase multiple is pretty crazy, and I like that I can point to a multiple that high when suitors want to buy into my own tech companies.

But for IBM this is a net win. Paying all that interest is basically a rounding error and means they barely spent any money for decades if they so choose.

That assumes zero growth, I think ibm obviously expects revenues and income to grow from red hat over time which would justify the purchase price. Whether or not that's warranted it's a different story, but the entirely of the price justification is probably not synergies - the cloud sector is growing pretty fast in general

I think that RedHat itself and the investments in CoreOS and other tech used in OpenStack is a pretty big thing for tethering in IBM. I think it's a better fit than, for contrast, Oracle. I do hope that the RH of old and some of the other bits remain Open Source friendly.

>Now consider that Red Hat had a net income of $433m.

I wonder how much of that is from IBM anyway..

Debt is reduced when inflation goes up. Perhaps they are predicting inflation?

As the very good comment above points out, IBM will need to cut costs very significantly regardless, as they've paid so much the interest on the debt is more than Red Hat makes.

So more an IP acquisition and IBM sure does know from decades of experience to recognise some company that fills a gap that has usurped their own offerings and acquired it.

You may well be right, indeed that was along the lines of my initial thought about this and would explain the size and scale of investment. Then if RH fails as they would currently to keep up those interest payments, then accountants can just rub their hands and use that debt to offset profits down the line.

Time will tell, certainly IBM has the kit and for years had its own dark fiber internet backbone globally, so have been well placed for years to capture the cloud market, yet failed to move on. Which for a company that saw a shift towards service offerings, was probably a big source of embarrassment internally at some levels.

Anyone with a neck beard better shave it, anyone with grey hairs better get a dye-job, Botox for anyone with wrinkles otherwise IBM will have them out by there ear quick.

You don't spend $34B to not interfere.

Q: What do you get when you merge IBM and RedHat?

A: IBM.

There is a lot of truth to this. Since Fedora is the upstream for Red Hat, and IBM historically kill off anything not making a profit, how long before this happens? I wonder if they'll split the two?

Red Hat does "control" a disproportionate amount of Linux development. Everything is also now basically dependent on systemd.

I'm seeing more and more IT guys I know move over to Free/OpenBSD because they don't like the direction Linux is taking. While Linux is only a kernel, the entire userland is basically dependent on systemd.

Linux has become what it hated in Windows. A massive, bloated mess. I've always preferred BSD on the server and something else on the desktop (hurry up, Haiku!). I still wish BeOS would have gotten more traction beyond the BeBox.

Methinks the move towards FreeBSD--and it's happening in quite a few circles, will continue, especially if IBM get heavy handed with Fedora/Red Hat. I'm not worried, per se, but I am concerned, for the aforementioned reasons.

IBM also put in billions of dollars into Linux. They (along with many many others) are part of the reason Linux became commercially successful.

https://www.wsj.com/articles/SB976650399196757666