UPDATED 15:36 EDT / OCTOBER 28 2018

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In a bombshell deal, IBM acquires open-source pioneer Red Hat for $34B

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In a deal sure to shake up the worlds of open-source software and cloud computing alike, IBM Corp. today announced a deal to acquire Red Hat Inc. for a stunning $34 billion.

Red Hat is one of the pioneers to commercialize open-source software, in which code is made freely available for others to redistribute and modify. Open-source software such as the Linux operating system, the web browser Firefox and big-data analysis software such as Apache Hadoop has gradually become the bedrock for many applications, even in large enterprises.

Making money from freely available software has been difficult for many companies, however — made obvious by the recently announced merger of open-source-based big-data firms Cloudera Inc. and Hortonworks Inc. Red Hat has been seen as the gold standard for providing services and support for open-source in a financially sustainable way.

But the company has struggled a bit lately. In its latest quarter reported last month, it reported disappointing earnings, causing its shares to fall. They’re down from about $175 in June to under $117 on Friday. Update: On Monday morning, Red Hat’s shares were shooting up 44 percent, to about $168 a share, while IBM’s shares were down 2.7 percent.

Still, IBM is paying $190 a share, and the $34 billion deal is not only the largest in IBM’s long history but the largest software acquisition ever. That signals the value it places on the company, which could add instant credibility to the computer and services giant’s multiyear efforts to make its platform for cloud applications more appealing to developers. In a similar but less pricey move in June, Microsoft Corp. bought open-source software hosting site GitHub Inc. for $7.5 billion, a deal that closed Friday.

“Red Hat could save IBM’s lack of developer traction,” said Stu Miniman, an analyst with SiliconANGLE Media Inc.’s market research group Wikibon. Moreover, he said, “IBM immediately bolsters its position in today’s multicloud world.”

Indeed, the move reflects IBM’s difficulty in keeping pace in the era of cloud computing. It recently surprised investors with quarterly earnings that showed a decline in revenue after several straight quarters of modest growth. Cloud computing giants such as Amazon Web Services Inc. and Microsoft have stolen a march on traditional makers of hardware and software such as IBM and Hewlett Packard Enterprise Co. by providing computing, storage, networking and applications — often from open source — as an online service.

Still, the premium IBM is paying for the open-source icon indicates it’s serious about making a bigger play for the cloud. “The acquisition of Red Hat is a game-changer,” Ginni Rometty, IBM’s chairman and chief executive, said in a statement. “It changes everything about the cloud market. IBM will become the world’s #1 hybrid cloud provider, offering companies the only open cloud solution that will unlock the full value of the cloud for their businesses.”

Rometty noted that most companies are still only about 20 percent along their way to the cloud. “The next 80 percent is about unlocking real business value and driving growth,” she said. “This is the next chapter of the cloud. It requires shifting business applications to hybrid cloud, extracting more data and optimizing every part of the business, from supply chains to sales.”

Red Hat CEO Jim Whitehurst added, “Joining forces with IBM will provide us with a greater level of scale, resources and capabilities to accelerate the impact of open source as the basis for digital transformation and bring Red Hat to an even wider audience — all while preserving our unique culture and unwavering commitment to open source innovation.”

The two companies emphasized the growing trend of companies to use multiple public and private clouds, which they said will require technologies such as Linux, software containers for enabling applications to run unchanged on different computers and cloud, and the container management software Kubernetes.

“IBM is committed to being an authentic multi-cloud provider, and we will prioritize the use of Red Hat technology across multiple clouds,” Arvind Krishna, senior vice president of IBM Hybrid Cloud, said in a statement. “In doing so, IBM will support open source technology wherever it runs, allowing it to scale significantly within commercial settings around the world.”

IBM and Red Hat are no strangers, having been partners for two decades. IBM has been a strong supporter of Linux, working with Red Hat to make it more bulletproof for large enterprises, not to mention IBM’s own $19 billion hybrid cloud business.

“IBM has a chance to strengthen on-premise assets and offerings,” said Holger Mueller, principal analyst at Constellation Research Inc. “Red Hat customers that want to remain on-premises are a large upsell market. But that is a shrinking business. Red Hat made bets to compensate for this, most prominently with OpenShift and a container platform. These are new products for IBM to sell.”

Anticipating concerns that the acquisition would endanger Red Hat’s appeal as an agnostic provider of open-source software, IBM said it will “remain committed to Red Hat’s open governance, open source contributions, participation in the open source community and development model, and fostering its widespread developer ecosystem.” In particular, they said they are committed to open-source efforts as Patent Promise, GPL Cooperation Commitment, the Open Invention Network and the LOT Network.

They also pledged that they’ll continue partnerships with AWS, Microsoft’s Azure cloud, Google LLC’s cloud, Alibaba Holdings Ltd. and others. Red Hat will become part of IBM’s hybrid cloud team as a “distinct unit,” with the same headquarters in Raleigh, North Carolina, and its brands.

For all that, maintaining Red Hat’s standing and culture could prove difficult for the company once known as Big Blue. It’s well-known for trying to integrate acquisitions into its huge organization, a process known internally as “blue-washing.”

“Red Hat was previously able to position itself as the Switzerland for on-premises computing,” Mueller said. “It remains to be seen if IBM can play the same role, which would be significant upside for IBM. But we will have to see if AWS and Google will partner as well with Red Hat now under new ownership as they did in the past.”

Moreover, it’s uncertain how much this will change the game, according to Patrick Moorhead, president and principal analyst at Moor Insights & Strategy.

“It’s not immediately obvious to me how the marriage between IBM and Red Hat brings combined value to the market,” he said. “Red Hat and IBM both participate in the enterprise and private cloud market together. This will likely impact IBM’s stature in the public cloud where the companies have a presence, but not nearly as much as the private cloud.”

Although the deal was approved by both companies’ boards, it’s not expected to close until well into next year. One analyst, Trip Chowdhry at Global Equities Research, suggested in a note to clients that China, whose infrastructure is built on Linux, might not grant its approval.

It’s also not inconceivable other companies could step in with higher bids that Red Hat shareholders might demand to be taken seriously. Among the possibilities are Google and Cisco Systems Inc., both aiming to boost their differing cloud strategies.

Photo: Red Hat

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