How the cloud wars forced IBM to buy Red Hat for $34 billion

IBM's purchase of Red Hat is a big bet on the hybrid and private cloud and the ability of Big Blue to manage multiple public cloud providers. Here are a few dynamics to ponder.

IBM paid $34 billion for Red Hat and a chance to be a cloud player -- private, public and hybrid -- with an ultimate goal of managing multiple clouds in the enterprise.

The Red Hat deal is IBM's biggest acquisition yet for a reason: The stakes are too high and IBM has already been bumped out of the big cloud conversation by Amazon Web Services, Google Cloud Platform and Microsoft Azure.

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Now you know the appeal of Red Hat. Sure, open source folks will worry about IBM's purchase, but Big Blue has been a good steward of open source. And yes, enterprises will go from Red Hat -- a proverbial Switzerland of software and the cloud -- to an IBM-Red Hat combination and one throat to choke.

But it's hard to argue the IBM-Red Hat logic. The game plan revolves around the hybrid cloud and managing multiple environments. Red Hat gives IBM software heft and an OpenStack playbook that can rival VMware, which incidentally has become quite cozy with AWS.

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The details are worth noting:

  • IBM will pay $190 per Red Hat share in cash.
  • IBM CEO Ginni Rometty dissed the public cloud and noted that most companies are 20 percent along the cloud journey and "renting compute power to cut costs." The next 80 percent is about hybrid cloud.
  • Red Hat CEO Jim Whitehurst said IBM will give it scale while preserving an open source commitment.
  • Both Red Hat and IBM said the combined company will accelerate "hybrid multi-cloud adoption."
  • Red Hat will remain a distinct unit in IBM's Hybrid Cloud unit and provide Big Blue with growth, software revenue and a way to grow the cloud business.
  • IBM said it will make the purchase with cash, credit and bridge lines, but did note that it would be disciplined to preserve its credit rating. IBM will stop buying back its own shares.

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Why Red Hat?

On a conference call, Rometty said the Red Hat deal, expected to close in the second half of 2019, said IBM's purchase is about preparing for the second chapter of the cloud. The two companies have been partners for decades and Rometty said IBM concluded that Red Hat would fuel growth across the company. "This is a very good opportunity to cross sell," said Rometty.

For instance, IBM will move its software as a service offerings to Red Hat's stack when appropriate, said Rometty. "We will use their stack to scale," she said.

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Red Hat can fuel services as well as Watson and digital transformation efforts designed to manage data better.

Rometty said:

The second chapter of the cloud is about something different. And we've been really building our business for this moment. And to lead in the second chapter, this is going to be about hybrid cloud. All clients today already have cloud. With the early cloud projects the easy work has been done.

It's mostly been about productivity and some client facing apps. But this is an inflection point, which is about all their processes and their data, they need this robust hybrid environment. The average client has 1,000 applications and the average client already have 5 -- in some cases as many as 16 -- clouds. They've got to move this. They either have to rewrite, refactor to secure the data, these all inhibitors that stop them from going.

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Strategically, IBM said Red hat can play into all of the company's high value efforts. Red Hat CEO Jim Whitehurst said IBM's scale will allow his company to grow faster and enable customers to benefit by breaking lock-in via an open source approach.

Whitehurst added:

We can leverage IBM's scale and resources to enhance the development and continue to improve our infrastructure, management, automation solutions and cloud data applications development. And by being able to leverage the power of IBM, it's scale, its depth in customer relationships, its industry vertical expertise, we're really excited that we can take a grow to a whole new level.

The premium IBM paid for Red Hat, however, is a big $34 billion pill to swallow. IBM CFO Bruce Kavanaugh said the company will get benefits from the Red Hat purchase quickly. Rometty added that IBM will also look at divesting businesses if it makes sense.

Keeping Red Hat's culture

Rometty said that IBM will keep Red Hat's culture, its employees and approach. "I want to preserve its brand and its culture," said Rometty. "It is very clear to us what horizontally stays neutral."

She added that IBM already open sources a lot of software. Rometty also said that IBM does Switzerland well given its services legacy.

Whitehurst said Red Hat will maintain its partnerships. "This is about helping customers solve their problems," said Whitehurst.

He added that partners including AWS, Google and Microsoft will be on board with the IBM-Red Hat deal because it grows the overall cloud pie for all.

Will this deal work?

Big mergers always sound great on day one, but skeptics abound. Steven Vaughn-Nichols already noted that employees are wary.

Patrick Moorhead, principal of Moor Insights & Strategy, said:

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

Wall Street types are likely to worry about the premium and IBM's ability to grow even with Red Hat.

After all, IBM's businesses -- including the cognitive and cloud businesses -- struggled in the third quarter. Red Hat can provide cross sell opportunities to juice growth on multiple fronts.

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Yes, IBM is clearly going with the private cloud spin, but the longer play is the multi-cloud management. Are you likely to use open standards to manage multiple clouds or something proprietary? IBM's bet is that Red Hat will give it a strong case to allow Big Blue to manage your clouds, AI and security.

What's unclear is whether enterprises will value a best-of-breed cloud approach or simply go with the lock-in, one throat to choke and simplicity of one vendor. There's a reason cloud providers can tout "all in" customers: Enterprises can resist the discounts. In 25 years of covering the tech industry, I've frequently been surprised by the ability of enterprises to repeat the same lock-in mistakes.

The IBM-Red Hat deal may be a hybrid play in another way. The bet is that enterprises will get their one big contract they are used to yet feel open enough to play with multiple vendors. IBM's Red Hat purchase is a way to attempt a cloud leap frog and rise above the public cloud battlefield that now consists of AWS, Microsoft and Google.