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IBM's 33-dollar deal for Red Hat fails 3 out of 4 tests for successful acquisitions




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KIEV, UKRAINE – 2018/10/25: The Red Hat Software Company Logo Appears on a Smartphone Red Hat, Inc. is an American multinational software company called Open Enterprise Community Source Software Products (Photo: Igor Golovniov / SOPA Images / LightRocket on Getty Images)

IBM is shrinking ̵

1; sales were down 2.1% in the last quarter – and its share has dropped by as much as 35 units

Is there a better time for the largest acquisition in its history? That's the price IBM will pay on Oct. 29 for $ 33 billion – a 63% premium over the October 26 closing price – taking on open source Software manufacturer Red Hat after CNBC

Red Hat provides services for its version of open source (free of license fees) Linux software operating systems, middleware, storage, virtualization and management tools. The company men reported revenue by gh two categories: subscriptions and training and services. In the financial year 2018, America contributed about 64% to total sales; Europe, the Middle East and Africa contributed 23%; and after Morningstar, the Asia-Pacific region contributed 14%.

Red Hat is a steadily growing and profitable company that pays off a lot of money. In the last five years, revenue increased 17.1% to $ 2.92 billion, net income increased 11.5% to $ 259 million, and free cash flow grew nearly 19% to $ 821 million.

Unfortunately, Red Hat slipped in its last quarter. At that time, it missed analysts' expectations of sales, and even the forecasts for the current quarter did not come out – investors could have feared that Red Hat would lose its business to competitors and that growth could slow down in recent years six months to 26th October fell by 28%.

Is that a good thing for IBM shareholders? Investors do not like this deal – they lowered their stocks by over 4% on October 29th. And I think they do not pass three of the four tests for successful acquisitions. (I have no financial interest in the securities mentioned in this article.)

To be fair, Red Hat competes in an attractive industry. However, the combined companies will not be better off, IBM will be heavily overpaid, and it will be difficult to integrate the two companies.

Industry Attractiveness: Pass

Red Hat's industry-providing service and training for companies that use open source software – is big, grows and is profitable. Jim Whitehurst, CEO of Red Hat, said in a statement from the SEC: "We believe that our addressable market will total $ 73 billion by 2021. If software is eating the world – and with digital transformation across all industries – it is really – open source is the key ingredient. "

In addition, IDC reported that Red Hat lagged behind only Microsoft in 2017 with 32.7% of the server operating system market. Within the Linux segment, IDC noted that adoption of Red Hat Enterprise Linux increased by nearly 20% in 2017.

Better Off: Fail

IBM and Red Hat have the deal under the name Possibility to compete with Amazon and Microsoft in the so-called Hybrid Cloud. But IBM's approach to integrating acquisitions makes it very unlikely that the merged companies will be able to better serve their customers and gain market share.

For one thing, IBM is known in its acquisitions for imposing internal requirements. For its products, products must appear in such a way that everyone works together and customers are forced to accept a chunky bundle instead of a more focused, efficient solution.

While IBM has been serving servers with Red Hat for years, saving this deal That IBM will pay Red Hat for it remains to be seen how well this deal will lead to a cloud service, IBM's modest 1.9% stake in Cloud Infrastructure revenue in 2017 may increase.

In addition, companies have purchased Red Hat products because it was considered vendor-neutral. Whitehurst, CNBC said that the combined company would be the largest contributor to open source software. "We will remain clear [also] because we want our customers to understand that Red Hat is a neutral sale."

But as part of IBM, Whitehurst will have an insurmountable challenge of explaining how Red Hat can be Both neutral and not trying to cash out the acquisition by encouraging customers to buy from IBM. This becomes particularly difficult as he loses control of his product line and market launch strategy due to Big Blue's bureaucracy.

Net Present Value Greater Than Zero: Failure

Paying so much Red Hat requires some heroic assumptions for this deal to generate positive capital value. IBM has an annual turnover of about $ 80 billion, and Red Hat would only bring 3.8 percent to Big Blue.

That's not much, but it could get worse. After all, it is assumed that customers will stay with Red Hat as soon as they are owned by IBM. Of course, companies that previously bought from Red Hat because they were perceived as neutral could choose to switch to an even more independent rival.

In addition, Red Hat would only contribute 6% to IBM's free cash flow. I am sure that it is possible to make assumptions that result in this 63% premium leading to a positive NPV. But I think IBM overpaid.

Integration: Fail

One of the main reasons that mergers fail is because the business acquired can not retain the best people in the acquired business. One factor that causes people to leave is a change in their culture. And Red Hat believes preserving his culture is critical to his success. According to their most recent annual report

we believe that a key factor in our success is our corporate culture, which we believe promotes innovation, creativity and collaboration. As our organization grows, our employees (including remote workers) and our resources are dispersed globally and our organizational management structures become more complex, it becomes increasingly difficult for us to maintain these positive aspects of our corporate culture. If we fail to maintain our corporate culture, we may have difficulty attracting and retaining motivated employees, continuing our work, or implementing our business strategy. This could affect our business, financial and earnings position as well as our cash flows .

Will this culture survive if adopted by IBM? Considering the gap between IBM's actual culture and that of Thomas Watson, I would vote no. But Rometty told Wall Street Journal that IBM wanted to keep the culture and brand of Red Hat.

To be fair, this is an outstanding deal for Red Hat shareholders, who will undoubtedly appreciate the huge premium that IBM paid. Unfortunately, IBM shareholders will be disappointed that the transaction failed the four tests for successful takeovers.

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KIEV, UKRAINE – 2018/10/25: The Red Hat Software Company's Logo Can Be Seen on the Smartphone Red Hat, Inc. is an American multinational software company dedicated to providing enterprise-class open source software products (Photo: Igor Golovniov / SOPA Images / LightRocket on Getty Images)

IBM Shrinking – Revenues Declining 2.1% The most recent quarter – and since the acquisition by the current CEO at the beginning of 2012, the stock is down Decreased 35%.

What better time for the largest acquisition in its history? $ 33 billion – a 63% premium over its October 26 closing – for the acquisition of open source software maker Red [CNN] .

Red Hat provides services for its version of the open source program Source (free of license fees) Linux software operating system s, middleware, storage, virtualization and manageme The company reports revenue in two categories: subscriptions and training and services. In the financial year 2018, America contributed about 64% to total sales; Europe, the Middle East and Africa contributed 23%; and after Morningstar, the Asia-Pacific region contributed 14%.

Red Hat is a steadily growing and profitable company that pays off a lot of money. In the last five years, revenue increased 17.1% to $ 2.92 billion, net profit increased 11.5% to $ 259 million, and free cash flow grew nearly 19% to $ 821 million Morningstar [19659033] Unfortunately, Red Hat slipped in its last quarter. At that time, it missed analysts' expectations of sales, and even the forecasts for the current quarter did not come out – investors could have feared that Red Hat would lose its business to competitors and that growth could slow down in recent years six months to 26th October fell by 28%.

Is that a good thing for IBM shareholders? Investors do not like this deal – they lowered their stocks by over 4% on October 29th. And I think they do not pass three of the four tests for successful acquisitions. (I have no financial interest in the securities mentioned in this article.)

To be fair, Red Hat competes in an attractive industry. However, the combined companies will not be better off, IBM will be heavily overpaid, and it will be difficult to integrate the two companies.

Industry Attractiveness: Pass

Red Hat's industry-providing service and training for companies that use open source software – is big, grows and is profitable. Jim Whitehurst, CEO of Red Hat, said in a statement from the SEC: "We believe that our addressable market will total $ 73 billion by 2021. If software is eating the world – and with digital transformation across all industries – it is really – open source is the key ingredient. "

In addition, IDC reported that Red Hat lagged behind only Microsoft in 2017 with 32.7% of the server operating system market. Within the Linux segment, IDC noted that adoption of Red Hat Enterprise Linux increased by nearly 20% in 2017.

Better Off: Fail

IBM and Red Hat have the deal under the name Possibility to compete with Amazon and Microsoft in the so-called Hybrid Cloud. But IBM's approach to integrating acquisitions makes it very unlikely that the merged companies will be able to better serve their customers and gain market share.

For one thing, IBM is known in its acquisitions for imposing internal requirements. For its products, products must appear in such a way that everyone works together and customers are forced to accept a chunky bundle instead of a more focused, efficient solution.

While IBM has been serving servers with Red Hat for years, saving this deal That IBM will pay Red Hat for it remains to be seen how well this deal will lead to a cloud service, IBM's modest 1.9% stake in Cloud Infrastructure revenue in 2017 may increase.

In addition, companies have purchased Red Hat products because it was considered vendor-neutral. Whitehurst, CNBC said that the combined company would be the largest contributor to open source software. "We will remain clear [also] because we want our customers to understand that Red Hat is a neutral sale."

But as part of IBM, Whitehurst will have an insurmountable challenge of explaining how Red Hat can be Both neutral and not trying to cash out the acquisition by encouraging customers to buy from IBM. This becomes particularly difficult as he loses control of his product line and market launch strategy due to Big Blue's bureaucracy.

Net Present Value Greater Than Zero: Failure

Paying so much Red Hat requires some heroic assumptions for this deal to generate positive capital value. IBM has an annual turnover of about $ 80 billion, and Red Hat would only bring 3.8 percent to Big Blue.

That's not much, but it could get worse. After all, it is assumed that customers will stay with Red Hat as soon as they are owned by IBM. Of course, companies that previously bought from Red Hat because they were perceived as neutral could choose to switch to an even more independent rival.

In addition, Red Hat would only contribute 6% to IBM's free cash flow. I am sure that it is possible to make assumptions that result in this 63% premium leading to a positive NPV. But I think IBM overpaid.

Integration: Fail

One of the main reasons that mergers fail is because the business acquired can not retain the best people in the acquired business. One factor that causes people to leave is a change in their culture. And Red Hat believes preserving his culture is critical to his success. According to their most recent annual report

we believe that a key factor in our success is our corporate culture, which we believe promotes innovation, creativity and collaboration. As our organization grows, our employees (including remote workers) and our resources are dispersed globally and our organizational management structures become more complex, it becomes increasingly difficult for us to maintain these positive aspects of our corporate culture. If we fail to maintain our corporate culture, we may have difficulty attracting and retaining motivated employees, continuing our work, or implementing our business strategy. This could affect our business, financial and earnings position as well as our cash flows .

Will this culture survive if adopted by IBM? Considering the gap between IBM's actual culture and that of Thomas Watson, I would vote no. But Rometty told Wall Street Journal that IBM wanted to keep the culture and brand of Red Hat.

To be fair, this is an outstanding deal for Red Hat shareholders, who will undoubtedly appreciate the huge premium that IBM paid. Unfortunately, IBM shareholders will be disappointed that the transaction failed the four tests for successful takeovers.


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