You probably heard the news: IBM is buying open-source pioneer Red Hat for a whopping $34 billion, paying a 63% premium to the company’s open-market price stock. It represents the largest software acquisition in history—and, interestingly, is actually a bet on a small business inside Red Hat that IBM must think represents the future of technology.
Right now, IBM—the old-line tech company trying to turbo-charge its growth–is trading at 1.5 times its anticipated $80 billion in revenues this year, and just over 10 times its operating margin. It is paying up nine times for Red Hat’s revenues and over 30 times the company’s operating margin. Indeed, while Red Hat’s $3 billion in revenues will only add another 4% to IBM’s total revenues, the newly acquired company will be worth a quarter of the 107-year old company’s valuation.
What makes this deal even more interesting is that a large chunk of the $3 billion that Red Hat generates each year comes from its legacy Enterprise Linux product (RHEL), which has seen decelerating growth recently. A much smaller portion of the company’s revenue is driven by its cloud-native product, OpenShift, which includes open-source tools for software developers, including container-orchestration product Kubernetes and container-format tool Docker, plus a few other goodies. All these tools make software developers more productive and efficient, and more broadly are helping transform how software is created and implemented across most enterprises and organizations today. So OpenShift is likely the focus of IBM’s interest in Red Hat.
Needless to say, there are tremendous expectations built in this deal, and it’s still unknown if IBM will be able to capitalize on OpenShift and extract shareholder value from the transaction. But there are some interesting implications here for others in the technology ecosystem, including large, existing datacenter companies as well as smaller, cloud-native upstarts.
“Hybrid cloud” is for real, and not all workloads are moving to public clouds.
A few years ago, the pendulum seemed to have shifted from companies deploying more-traditional, on-premise datacenter infrastructure to using hot public cloud-computing vendors, most notably Amazon. In the last few years, however, we’ve seen that most mission-critical apps inside companies are still running on a private cloud, albeit modernized by agile software and microservices to speed up innovation. Private cloud represents 15-20% of datacenter spend, and the combo of private plus one or more public clouds – aka “hybrid” cloud–is here to stay, especially for enterprises. Red Hat’s OpenShift technology enables on-premise, private cloud deployments, giving IBM the ability to play in the hybrid cloud.
Amazon Web Services is still the king of the hill, but the public-cloud battle is far from over.
AWS timed its rise perfectly and truly deserves the credit for taking excess IT infrastructure at e-commerce company Amazon and making a real business out of it. At around $20 billion in revenues and 30% operating margins, AWS has to be the fastest-growing tech company, or any company, that we have seen in decades. Even so, the cloud game is only in its first or second inning; there is still plenty of time for the $300 billion in industry datacenter spend to move further to the cloud, and for competing cloud vendors Azure, Google Cloud and others catch up to AWS. The on-premise, legacy vendors – IBM, Dell-EMC, Cisco, HPE and others–are also hoping to ride the wave, and IBM-Red Hat may now have a better hybrid-cloud story than the other datacenter incumbents’ private cloud story.
The game has shifted from IT infrastructure to developer productivity.
The last couple of decades have seen market value accrue to infrastructure innovators like VMware, Red Hat, Pivotal and others whose products make IT infrastructure elastic, agile and cost effective. The game has decidedly shifted to the developer layer, whereby the 19 million software developers worldwide control the keys to the IT kingdom. Today, developer adoption is seen as the leading indicator of digital transformation, and it heavily influences IT purchasing decisions. Indeed, Microsoft’s $7.5 billion acquisition of GitHub to accelerate mindshare in the developer community in many ways kicked off the party. The $34 billion IBM is paying for Red Hat also largely factors in the company’s future ability to gain mindshare with the eight million developers with whom Red Hat engages, above and beyond the minimal revenue or EBITDA impact the acquisition will generate.
And last but not least – the future of cloud is “open”.
We fundamentally believe that open source should not be perceived as a proxy for free or cheap software, but instead for modern, cutting-edge software. Many of the world’s most popular open-source projects – be they Hadoop, Spark, MongoDB, Kafka or others–represent innovation from some of the brightest minds in the business working for transformative companies like Google, Facebook and LinkedIn, among others.
By democratizing access to cutting-edge innovation, open-source projects usher in collaboration among developers and DevOps engineers, and make innovation readily available to large enterprises on the verge of digital transformation. Red Hat is one of the key members that pioneered the open-source wave, and the company ranked at the top of the Battery Open Source Software (BOSS) Index that we launched last year. Besides building mindshare, Red Hat also successfully commercialized the open-source business model and benefitted from it commercially, as have other companies that have staged recent IPOs – Elastic, MongoDB, Cloudera and Talend, to name a few.
IBM sees open-source innovation as the key to the hybrid-cloud market, and its move to buy Red Hat signals the company’s commitment to producing cutting-edge software to help its hybrid-cloud customers succeed.
The future of the cloud will be influenced heavily by open source, and this combination of the IBM sales machine plus Red Hat’s open-source legacy will, I think, cause other large datacenter players to pursue acquisitions of, and partnerships with, new open-source and DevOps upstarts. Now, Dell-EMC, VMware, HPE, Cisco and others have to up their game.
I, for one, am excited to witness how the other elephants will dance to the tune of hybrid cloud to survive, and thrive.
This article originally appeared on Forbes.
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