IBM makes a move in cloud space with $34B deal to buy Red Hat

IBM is looking to be a bigger player in the cloud space with its $34 billion deal to buy Red Hat, which was announced Sunday night.

IBM will acquire all of the issued and outstanding common shares of Red Hat for $190 per share in cash, representing a total enterprise value of approximately $34 billion. That price tag was a 63% premium over Red Hat’s closing price of $116.68 per share on Friday.

“The acquisition of Red Hat is a game-changer. It changes everything about the cloud market,” said Ginni Rometty, IBM chairman, president and chief executive officer. “IBM will become the world’s No. 1 hybrid cloud provider, offering companies the only open cloud solution that will unlock the full value of the cloud for their businesses."

Red Hat's Kubernetes portfolio is key to the deal. Red Hat bought CoreOS, which includes its Kubernetes-based Tectonic orchestration system, for $250 million at the start of this year to improve its automation capabilities in Kubernetes. Earlier this month, Red Hat announced an update to its OpenShift application development platform based on Kubernetes that added tools for IT developers.

IBM has lagged behind Amazon Web Services, Microsoft Azure and Google in the cloud space, but it does bring artificial intelligence and machine learning technologies to the deal. With Red Hat in hand, IBM has a larger presence in both the hybrid and private cloud.

"By merging, they’re trying to improve their cloud position. We see them looking to use the disruptive container/Kubernetes to create a new hybrid cloud platform," Oppenheimer Tim Horan wrote in a report on the deal. "Given how far behind they are in infrastructure, they may look to partner much more with Google."

Horan said the combined IBM/Red Hat posed a bigger threat to Microsoft due to Amazon Web Services' commanding lead in the cloud market and because Microsoft is dominant hybrid cloud compute company.

If the integration of Red Hat and IBM proves to be successful, Horan said it would take several years before it has an impact on Microsoft in the cloud sector.

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Amazon Web Services and Microsoft's capex numbers are $26 billion and $16 billion, respectively, while IBM/Red Hat's is in the $3.3 billion range this year. Google's planned capex spend is $23 billion this year, according to research by Jefferies.

"At the end of the day, cloud compute is a combination of massive amounts of infrastructure with compute storage, and processing and software squeezing huge productivity improvements out of that infrastructure and computer hardware," Horan wrote in his report. "The model is shifting to more distributed/serverless/containers, and blockchain has the potential to shift the cloud model further. This does open up an opportunity for a combined IBM/Red Hat to enter the market with a new service. However, we think they still have a long way to go before they can compete with Microsoft and Amazon in cloud."

IBM and Red Hat aren't strangers to each other due to a partnership that spans 20 years. IBM was an early supporter of Linux and worked with Red Hat to help develop and grow enterprise-grade Linux products and services and, more recently, to bring enterprise Kubernetes and hybrid cloud solutions to customers. Those innovations have become core technologies within IBM’s $19 billion hybrid cloud business.

Similar to Microsoft's recent deal to buy coding community GitHub, IBM pledged it would remain committed to Red Hat’s open governance, open source contributions, participation in the open source community and development model while also fostering its widespread developer ecosystem. Upon closing of the deal, Red Hat will join IBM’s Hybrid Cloud team as a distinct unit.

Red Hat will continue to be led by CEO and President Jim Whitehurst and Red Hat’s current management team. Whitehurst also will join IBM’s senior management team and report to Rometty. IBM intends to maintain Red Hat’s headquarters, facilities, brands and practices.

IBM will also continue to work with the other cloud providers that Red Hat had partnered with including Amazon Web Services, Microsoft Azure, Google Cloud and Alibaba.

Red Hat stands to gain traction in the marketplace from IBM's global sales presence. The two companies said that Red Hat would benefit from IBM’s hybrid cloud and enterprise IT scale in push its open source technology portfolio to businesses globally.