Summary
- IBM’s acquisition of Red Hat promises to deliver a company that can be a leader in the hybrid cloud sphere.
- The hybrid cloud market is valued at an estimated US$ 1.2 trillion, and IBM is confident that it can capture a significant chunk of that value by offering a stack.
- Chapter 2 of the digitalization process is said to be under way, this will see the migration of the remaining 80% of movable workloads to the cloud.
- At current prices, the stock is cheap and investors would do well to hold over the medium to long term.
Having just finalized its purchase of Red Hat Inc. (RHT), International Business Machines (IBM) held an insightful briefing session for investors, releasing a new set of growth projections to 2021. The rationale for the RHT acquisition is clear - while IBM's core business has been growing, the IBM-RHT combination creates a hybrid cloud player, distinct in that it bridges the gap between traditional infrastructure, private and public clouds.
Though I was initially skeptical on the RHT acquisition prior to the investor briefing (IBM did pay 10.7x EV/NTM subscription revenue), I have changed my mind on the IBM-RHT story and I see a path for this acquisition to ultimately turn out successful, driving sales of IBM's existing products and services while boosting RHT's market share, in part by preserving that which made RHT worth buying in the first place.
At 10x earnings, the market is offering IBM at reasonable prices and investors may well see a good return if IBM can meet projections, with the caveat that the current market turmoil may make this recommendation suitable only for those that have the patience to hold for several years.
Investor Briefing Highlights
IBM delivered an insightful investor briefing some 3 weeks after its acquisition of RHT had closed. The major message coming out of it was that IBM is now the best-positioned player chasing a $1.2 trillion hybrid-cloud market.
The hybrid cloud, which allows the movement of data and applications between public and private clouds and traditional IT infrastructure, should drive chapter 2 of IBM's digital reinvention. In the first chapter, around 20% of client activity was moved to the cloud in some form, but this was largely user-facing front-end applications. The remaining 80%, the back-end and core applications, can be moved, scaled-up and have artificial intelligence (AI) and machine learning (ML) embedded in the cloud, and this is what chapter 2 is all about. IBM management gave a nice analogy of chapter 1 as being about offering a new insurance product and making it easy for clients to purchase, but chapter 2 is all about dealing with the day that a claim has to be made; nuts and bolts stuff.
Buying RHT is a milestone event for IBM and its hybrid cloud strategy. By allowing their clients to seamlessly integrate the ~80% of enterprise IT solutions that have not migrated to the cloud, with and between public and private clouds, IBM can offer a best of both worlds package. A big advantage to a platform like RHT is that the public clouds (e.g., Azure and IMB Cloud) which are likely to absorb the bulk of the migration can be bridged. IBM manages over two-thirds of the world's business data and RHT will help IBM move its customer's workloads into the cloud space and reach more companies that are entirely cloud-based. IBM will expand distribution - it sells to 95% of the Fortune 500, a big potential market for RHT's services - and assume its mid-teen sales growth.
