IBM has closed its $34 billion acquisition of Red Hat, vowed to keep its new unit independent, deliver innovative hybrid cloud stacks and grow. Now all IBM CEO Ginni Rometty has to do is execute since the Red Hat purchase will define her tenure.
For customers of both companies, the next big milestone will be to see the roadmap for hybrid cloud integrations that can compete with VMware in enterprises. In addition, IBM has pledged to keep Red Hat neutral, open-source focused and led by current management and CEO Jim Whitehurst.
What IBM is trying to do is use its scale to turbocharge Red Hat's growth as well as bolster its cloud unit. Red Hat's platform will instantly become global.
Rometty said IBM with Red Hat is well-positioned for the next phase of the cloud, which will include multiple vendors, clouds and systems. Whitehurst, who will report to Rometty, said the Red Hat will get the scale to make open source technology a de facto enterprise standard.
Here are the key items to watch now that Red Hat is part of IBM.
Can Red Hat growth continue and grow IBM overall? IBM's cloud revenue is 25% of total sales on a run rate of $19 billion, but Red Hat is small with fiscal 2019 sales of $3.4 billion, up 15% from a year ago. IBM will be able to integrate and sell more Red Hat software, but the two companies were already long-time partners. IBM said that Red Hat should deliver two points of compound annual revenue growth to IBM over five years. Big Blue will obviously want to top those expectations.
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Evercore analyst Amit Daryanani said in a research note that IBM won't initially get a big growth pop from Red Hat since it can't recognize the company's deferred revenue right away.
Although Red Hat's revenue profile is fairly substantial (we estimate close to ~$4 billion for its FY20 ended in February) with strong levels of profitability (~24% operating margin), we note that purchase accounting treatment of the target company's deferred revenue ($2.8B) will make IBM unable recognize a meaningful portion of Red Hat's deferred revenue as it converts to actual revenue (near-term transitory impact); this is while IBM will have to incur 100% of Red Hat's operating expense.
Daryanani said free cash flow will be a better way to see Red Hat's impact on IBM's financials.
On a conference call, Paul Cormier, president of products & technologies at Red Hat, said that the company has been focused on using open source to build a portfolio around hybrid cloud. "Today what we start on is that journey on steroids. It's something that would have taken us many years to do it at all," he said.
Will Red Hat truly remain neutral and independent? IBM buying Red Hat is probably the best outcome if you believe in open source. Both companies can blend well. What remains to be seen is whether Red Hat truly remains neutral and run by current management. Companies often merge, promise independence and the best of both worlds and then they're done in by infighting.
Whitehurst said in a memo to employees:
You've heard me say this before, but it bears repeating, Red Hat is still Red Hat. IBM is committed to preserving Red Hat's independence, neutrality, culture and industry partnerships.
I know you want to know what this means for you and it's pretty straightforward. Our mission, our culture, our 'community first' commitment, our product portfolio, our leadership team, our day-to-day operations, our brand and our soul are going to remain the same. Our unwavering commitment to open source—and all that it takes to bring it into the enterprise—is what makes us Red Hat. That is not changing.
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What's more interesting in the independent Red Hat approach is how the sales teams between the companies will be different.
Arvind Krishna, senior vice president at cloud and cognitive software at IBM, reiterated that Red Hat will remain the "Switzerland of IT."
Red Hat product teams will make their decisions on their plan. And make their plan on how they contribute to open source. That side is easy. The real question will be our behavior with clients and partners. Red Hat will have an independent sales team. This is a world of coopetition. Red Hat supports every hardware vendor out there and that will continue. Those partnerships will remain confidential. That's what we mean by neutrality and independence.
Cormier added that Red Hat sales team won't be compensated on selling IBM products. "Independence is essential to ensuring Red Hat partners will have an equal shot (in competing with IBM). Red Hat and IBM feels strongly about that," he said.
What's the roadmap look like? IBM and Red Hat customers may see further integrations and combinations as soon as late summer. The companies are going to have to outline their roadmaps sooner rather than later.
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Is IBM-Red Hat a multi-cloud point guard? IBM reiterated that with Red Hat it will continue to expand partnerships with all the leading cloud providers such as Amazon Web Services, Microsoft Azure, Google Cloud, and Alibaba. It's clear that multi-cloud is the future, but a lot of enterprises have bet on VMware with Dell Technologies hardware to blend private and public clouds.
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And will developers stick with Red Hat? It is worth noting that Red Hat and IBM spent a lot of digital ink on what the deal means for developers. First, IBM reiterated its commitment to open source. Then Red Hat outlined that its developer experience won't change and its programs and resources remain.
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