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IBM $34B Red Hat Acquisition: Pivot To Growth But Questions Remain

IBM $34B Red Hat Acquisition: Pivot To Growth But Questions Remain

>>From the SiliconANGLE Media office in Boston, Massachusetts, it’s theCUBE. Now here are your hosts, Dave
Vellante and Stu Miniman.>>Hi everybody, Dave Vellante
here with Stu Miniman. We’re here to unpack
the recent acquisition that IBM announced of Red Hat. $34 billon acquisition
financed with cash and debt. And Stu, let me get us started. Why would IBM spend
$34 billion on Red Hat? Its largest acquisition to date of a software company had
been Cognos at $5 billion. This is a massive move. IBM’s Ginni Rometty called
this a game changer. And essentially, my take
is that they’re pivoting. Their public cloud strategy was not living up to expectations. They’re pivoting to hybrid cloud. Their hybrid cloud strategy was limited because they didn’t really
have strong developer mojo, their Bluemix PaaS
layer had really failed. And so they really needed to make a big move here, and this is a big move. And so IBM’s intent, and
Ginni Rometty laid out the strategy, is to become number one in hybrid cloud, the undisputed leader. And so we’ll talk about that. But Stu, from Red Hat’s perspective, it’s a company you’re very close to and you’ve observed for a number of years, Red Hat was on a path touting a $5 billion revenue plan, what happened? Why would they capitulate?>>Yeah Dave, on the face of it, Red Hat says that IBM will help
it further its mission. We just listened to Arvin Krishna from IBM talking with Paul Cormier at Red Hat, and they talked about how they were gonna keep the Red Hat brand alive. IBM has a long history with open source. As you mentioned, I’ve been working with Red Hat, gosh, almost 20 years now, and we all think back to two decades ago, when IBM put a billion dollars into Linux and really pushed on open source. So these are not strangers, they know each other really well. Part of me looks at these
from a cynicism standpoint. Somebody on Twitter said
that Red Hat is hitting it at the peak of Kubernetes hype. And therefore, they’re gonna get maximum valuation for where the stock is. Red Hat has positioned itself rather well in the hybrid cloud world,
really the multicloud world, when you go to AWS, when you go to the Microsoft Azure
environment, you talk to Google. Open source fits into that
environment and Red Hat products specifically tie
into those environments. Remember last year, in Boston, there’s a video of Andy Jassy talking about a partnership with Red Hat. This year, up on stage, Microsoft with Azure partnering deeply with Red Hat. So Red Hat has done a nice
job of moving beyond Linux. But Linux is still at its core. There definitely is concern that the operating system is less important today than it was in the past. It was actually Red Hat’s acquisition of CoreOS for about $250
million earlier this year that really put a fine point on it. CoreOS was launched to
be just enough Linux to live in this kind of
container and Kubernetes world. And Red Hat, of course,
like we’ve seen often, the company that is saying,
“We’re going to kill you”, well you go and you buy them. So Red Hat wasn’t looking to kill IBM, but definitely we’ve seen
this trend of softwares eating the world, and open
sources eating software. So IBM, hopefully, is a
embracing that open source ethos. I have to say, Dave, for myself, a little sad to see the news. Red Hat being the paragon of open source. The one that we always go to
for winning in this space. So we hope that they will be
able to keep their culture. We’ve had a chance, many times, to interview Jim Whitehurst,
really respected CEO. One that we think should stay involved in IBM deeply for this. But if they can keep and grow the culture, then it’s a win for Red Hat. But still sorting through everything, and it feels like a little bit of a capitulation that Red Hat decides to sell off rather than keep its mission of getting to five billion and beyond, and be the leading company in the space.>>Well I think it is a
bit of a capitulation. Because look, Red Hat is roughly a $3 billion company,
growing at 20% a year, had that vision of five billion Its stock, in June, had hit $175. So while IBM’s paying a 60% premium off of its current price, it’s really only about 8 or 9% higher than where Red Hat was just a few months ago. And so I think, there’s an
old saying on Wall Street, the first disappointment
is never the last. And so I think that Red Hat
was looking at a long slog. They reduced expectations,
they guided lower, and they were looking at
the 90-day shot clock. And this probably wasn’t going to be a good ‘nother couple
of years for Red Hat. And they’re selling at
the peak of the market, or roughly the peak of the market. They probably figured, hey, the window is closing, potentially, to do this deal. Maybe not such a bad time to get out, as opposed to trying to slog it out. Your thoughts.>>Yeah, Dave, I think
you’re absolutely right. When you look at where Red Hat is winning, they’ve done great in
OpenStack but there’s not a lot of excitement around OpenStack. Kubernetes was talked about
lots in the announcement, in the briefings, and
everything like that. I was actually surprised you didn’t hear as much about just the core business. You would think you would be hearing about all the companies using Red Hat Enterprise Linux around the world. That ratable model that Red Hat really has a nice base of their environment. It was talking more about the future and where Kubernetes, and cloud-native, and all of that development will go. IBM has done middling
okay with developers. They have a strong history in middleware, which is where a lot of the Red Hat development activity has been heading. It was interesting to hear, on the call, it’s like, oh well, what about the customers that are using IBM too say, “Oh well, if customers want
that, we’ll still do it.” What about IBM with Cloud Foundry? Well absolutely, if customers wanna still be doing it, they’ll do that. So you don’t hear the typical, “Oh well, we’re going to
take Red Hat technology “and push it through
all of IBM’s channel.” This is in the IBM cloud group, and that’s really their focus, as it is. I feel like they’re almost limiting the potential for growth for Red Hat.>>Well so IBM’s gonna pay for this, as I said, it’s an all cash deal. IBM’s got about 14 and a half billion dollars on the balance sheet. And so they gotta take out some debt. S&P downgraded IBM’s
rating from an A+ to an A. And so the ratings agency is going to be watching IBM’s growth. IBM said this will add 200 basis points of revenue growth over the five year CAGR. But that means we’re really not gonna see that for six, seven years. And Ginni Rometty stressed this is not a backend loaded thing. We’re gonna find revenue opportunities through cross-selling and go-to-market. But we have a lot of
questions on this deal, Stu. And I wanna sorta get into that. So first of all, again, I think
it’s the right move for IBM. It’s a big move for IBM. Rumors were that Cisco
might have been interested. I’m not sure if Microsoft was in the mix. So IBM went for it and,
as I said, didn’t pay a huge premium over where
their stock was back in June. Now of course, back in June, the market was kind of inflated. But nonetheless, the strategy
now is to go multi-cloud. The number one in the multi-cloud world. What is that multi-cloud leadership? How are we gonna measure multi-cloud? Is IBM, now, the steward of
open source for the industry? To your point earlier,
you’re sad, Stu, I know.>>You bring up a great point. So I think back to three years ago, with the Wikibon we put together, our true private cloud forecast. And when we built that, we said, “Okay, here’s the hardware, and software, “and services in private cloud.” And we said, “Well let’s try
to measure hybrid cloud.” And we spent like, six
months looking at this. And it’s like, well what is hybrid cloud? I’ve got my public cloud pieces, and I’ve got my private cloud pieces. Well there’s some management layers and things that go in between. Do I count things like PaaS? So do you save people like
Pivotal and Red Hat’s OpenShift? Are those hybrid cloud? Well but they live either here or there. They’re not usually necessarily helping with the migration and moving around. I can live in multiple environments. So Linux and containers
live in the public, they live in the private, they don’t just fly around in the ether. So measuring hybrid cloud,
I think is really tough. Does IBM plus Red Hat
make them a top leader in this hybrid multi-cloud world? Absolutely, they should
be mentioned a lot more. When I go to the cloud shows,
the public cloud shows, IBM isn’t one of the first
peak companies you think about. Red Hat absolutely is in the conversation. It actually should raise the profile of Red Hat because, while Red Hat plays in a lot of the conversations, they’re also not the first company that comes to mind when
you talk about them. Microsoft, middle of hybrid cloud. Oracle, positioning their applications in this multi-cloud world. Of course you can’t talk about cloud, any cloud, without talking about Amazon’s position in the marketplace. And SAS is the real place that it plays. So IBM, one of their biggest strengths is that they have applications. Dave, you know the space really well. What does this mean vis-à-vis Oracle?>>Well let’s see, so Oracle, I think, is looking at this, saying, alright. I would say IBM is Oracle’s number one competitor in the enterprise. You got SAP, and Amazon obviously in cloud, et cetera, et cetera. But let me put it this way, I think Oracle is IBM’s number one competitor. Whether Oracle sees it that way or not. But they’re clearly similar companies, in terms of their vertical integration. I think Oracle’s looking
at this, saying, hey. There’s no way Oracle was gonna spend $34 billion on Red Hat. And I don’t think they were interested in really spending any money
on the alternatives. But does this put
Canonical and SUSE in play? I think Oracle’s gonna look at this and sort of message to its customers, “We’re already number one in
our world in hybrid cloud.” But I wanna come back to the deal. I’m actually optimistic on the deal, from the standpoint of, I think IBM had to make a big move like this. Because it was largely just bumping along. But I’m not buying the narrative from Jim Whitehurst that, “Well
we had to do this to scale.” Why couldn’t they scale with partners? I just don’t understand
that. They’re open. This is largely, to me, a services deal. This is a big boon for
IBM Services business. In fact, Jim Whitehurst,
and Ginni even said that today on the financial analyst call, Jim said, “Our big constraint was “services scale and the
industry expertise there.” So what was that constraint? Why couldn’t they partner with Accenture, and Ernie Young, and PwC,
and the likes of Deloitte, to scale and preserve
greater independence? And I think that the reason is, IBM sees an opportunity and they’re
going hard after it. So how will, or will,
IBM change its posture relative to some of
those big services plays?>>Yeah, Dave, I think you’re
absolutely right there. Because Red Hat should’ve
been able to scale there. I wonder if it’s just that all of those big service system
integrators, they’re working really closely with the
public cloud providers. And while Red Hat was a piece of it, it wasn’t the big piece of it. And therefore, I’m worried
on the application migration. I’m worried about the adoption of infrastructure as a service. And Red Hat might be
a piece in the puzzle, but it wasn’t the driver for
that change, and the move, and the modernization
activities that were going on. That being said, OpenShift
was a great opportunity. It plays in a lot of these environments. It’ll be really interesting to see. And a huge opportunity for IBM to take and accelerate that business. From a services standpoint, do you think it’ll change their position
with regard to the SIs?>>I don’t. I think IBM’s gonna try to present, preserve Red Hat as an
independent company. I would love to see IBM
do what EMC did years ago with VMware, and float some
portion of the company, and truly have it at least
be quasi-independent. With an independent operating
structure, and reporting structure from the standpoint
of a public company. That would really signal to the partners that IBM’s serious about
maintaining independence.>>Yeah now, look Dave,
IBM has said they will keep the brand, they
will keep the products. Of all the companies
that would buy Red Hat, I’m not super worried about
kinda polluting open source. It was kinda nice that
Jim Whitehurst would say, if it’s a Red Hat thing,
it is 100% open source. And IBM plays in a lot
of these environments. A friend of mine on Twitter was like, “Oh hey, IBM’s coming back to OpenDaylight or things like that.” Because they’d been part of Cloud Foundry, they’d been part of OpenDaylight. There’s certain ones that they are part of it and then they step back. So IBM, credibly open source space, if they can let Red Hat
people still do their thing. But the concern is that lots of other companies are gonna be calling up project leads, and contributors in the open source community that might’ve felt that Red Hat was ideal place to live, and now they might go get
their paycheck somewhere else.>>There’s rumors that Jim Whitehurst eventually will take over IBM. I don’t see it, I just
don’t think Jim Whitehurst wants to run Z mainframes and Services. That doesn’t make any sense to me. Ginni’s getting to the age where IBM CEOs typically retire, within
the next couple of years. And so I think that it’s more likely they’ll bring in somebody from internally. Whether it’s Arvin or,
more likely, Jim Kavanaugh ’cause he’s got the
relationship with Wall Street. Let’s talk about winners and losers. It’s just, again, a huge
strategic move for IBM. Frankly, I see the big
winners is IBM and Red Hat. Because as we described before, IBM was struggling with its execution, and Red Hat was just basically, finally hitting a wall after
60-plus quarters of growth. And so the question is,
will its customers win? The big concern I have
for the customers is, IBM has this nasty habit of raising prices when it does acquisitions. We’ve seen it a number of times. And so you keep an eye on it,
if I were a Red Hat customer, I’d be locking in some
attractive pricing, longterm. And I would also be
calling Mark Shuttleworth, and get his take, and get that Amdahl coffee cup on my desk, as it were. Other winners and losers, your thoughts on some of the partners,
and the ecosystem.>>Yeah, when I look at this and say, compare it to Microsoft buying GitHub. We’re all wondering, is this
a real game changer for IBM? And if they embrace the direction. It’s not like Red Hat culture is going to just take over IBM. In the Q&A with IBM, they said, “Will there be influence? Absolutely. “Is this a marriage of equals? No. “We’re buying Red Hat and we will be “communicating and
working together on this” But you can see how this can
help IBM, as to the direction. Open source and the multi-cloud world is a huge, important piece. Cisco, I think, could’ve
made a move like this. I would’ve been a little bit more worried about maintaining
open source purity, if it was somebody like Cisco. There’s other acquisitions, you mentioned Canonical and SUSE are out there. If somebody wanted to do this, the role of the operating system is much less important than it is today. You wouldn’t have seen Microsoft up on stage at Red Hat Summit this year if Windows was the driver
for Microsoft going forward. The cloud companies out
there, to be honest, it really cements their
presence out there. I don’t think AWS is sitting there saying, “Oh jeez, we need to worry.” They’re saying, “Well IBM’s capitulated.” Realizing that, “Sure
they have their own cloud, “and their environment,
but they’re going to be “successful only when they live in, “and around, and amongst
our platform of Amazon.” And Azure’s gonna feel the same
way, and same about Google. So there’s that dynamic there.>>What about VMware?>>So I think VMware
absolutely is a loser here. When I went back to say one of the biggest strengths of IBM is that
they have applications. When you talk about Red
Hat, they’re really working, not only at the infrastructure layer, but working with developers, and working in that environment. The biggest weakness of VMware, is they don’t own the applications. I’m paying licenses to VMware. And in a multi-cloud world,
why do I need VMware? As opposed to Red Hat and IBM, or Amazon, or Microsoft, have a much
more natural affinity for the applications and
the data in the future.>>And what about the arms dealers? HPE and Dell, in particular,
and of course, Lenovo. Wouldn’t they prefer Red
Hat being independent?>>Absolutely, they would prefer that they’re gonna stay independent. As long as it doesn’t seem to customers that IBM is trying to
twist everybody’s arms, and get you on to Z, or
Power, or something like that. And continues to allow partnerships with the HPEs, Dells,
Lenovos of the world. I think they’ll be okay. So I’d say middling to impact. But absolutely, Red
Hat, as an independent, was really the Switzerland
of the marketplace.>>Ginni Rometty had
sited three growth areas. One was Red Hat scale and go-to-market. I think there’s no question about that. IBM could help with
Red Hat’s go-to-market. The other growth vector was IBM’s products and software on the Red Hat stack. I’m less optimistic there, because I think that it’s the strength of IBM’s products, in and of themselves, that are largely gonna determine that success. And then the third was Services. I think IBM Services
is a huge winner here. Having the bat phone into Red Hat is a big win for IBM Services. They can now differentiate. And this is where I think it’s gonna be really interesting to see the posture of Accenture and those other big guys. I think IBM can now somewhat differentiate from those guys, saying, “Well wait, “we have exclusive, or not exclusive, “but inside baseball access to Red Hat.” So that’s gonna be an
interesting dynamic to watch. Your final thoughts here.>>Yeah, yeah, Dave, absolutely. On the product integration piece, the question would be,
you’re gonna have OpenAPIs. This is all gonna work
with the entire ecosystem. Couldn’t IBM have done
more of this without having to pay $34 billion
and put things together? Services, absolutely,
will be the measurement as to whether this is successful or not. That’s probably gonna
be the line out of them in financials, that we’re
gonna have to look at. Because, Dave, going back to, what is hybrid, and how do we measure it? What is success for this whole
acquisition down the line? Any final pieces to what we should watch and how we measure that?>>So I think that, first
of all, IBM’s really good with acquisitions, so keep an eye on that. I’m not so concerned about the debt. IBM’s got strong free cash flow. Red Hat throws off a billion dollars a year in free cash flow. This should be an accretive acquisition. In terms of operating profits, it might take a couple of years. But certainly from a standpoint of free cash flow and revenue growth, I think it’s gonna help near-term. If it doesn’t, that’s something that’s really important to watch. And then the last thing is culture. You know a lot of people
at these companies. I know a lot of people at these companies. Look, the Red Hat culture
drinks the Kool-Aid of open. You know this. Do they see IBM as the steward of open, and are they gonna face a brain drain? That’s why it’s no
coincidence that Whitehurst and Rometty were down
in North Carolina today. And Arvin and Paul Cormier
were in Boston today. This is where a lot of
employees are for Red Hat. And they’re messaging. And so that’s very, very
important. IBM’s not foolish. So that, to me, Stu, is a
huge thing, is the culture. Dave, IBM is no longer the navy suit with the red tie, and
everybody buttoned down. People are concerned about like, oh, IBM’s gonna give the Red
Hat people a dress code. Sure, the typical IBMer is not in a graphic tee and a hoodie. But, Dave, you’ve seen
such a transformation in IBM over the last couple of decades.>>Yeah, definitely. And I think this really does, in my view, cement, now, the legacy of Ginny Rometty, which was kinda hanging on Watson, and Cognitive, and this
sort of bespoke set of capabilities, and the
SoftLayer acquisition. It, now, all comes together.
This is a major pivot by IBM. I think, strategically,
it’s the right move for IBM. And I think, if in fact, IBM can maintain Red Hat’s independence and that posture, and maintain its culture
and employee base, I think it does change the game for IBM. So I would say, smart move, good move. Expensive but probably worth it.>>Yeah, where else would they
have put their money, Dave?>>Yeah, right. Alright, Stu, thank you very much for unpacking this announcement. And thank you for watching.
We’ll see you next time. (mellow electronic music)

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