BIG BLUE is donning red headgear. Even a few months ago the idea that IBM, a venerable corporate information-technology (IT) firm, would buy Red Hat, the biggest vendor of open-source software, would have been considered highly unlikely, not least because of IBM’S aversion to big mergers. But on October 28th IBM announced that it would take over the firm for $34bn, which represents a 63% premium over Red Hat’s closing share price at the end of last week. The deal is the biggest ever in software and shows how fundamentally the IT industry has changed—and how much pressure IBM felt to do something to get out of its funk.
Red Hat is no household name, but in the IT industry the firm is considered one of the biggest success stories of the recent past. Founded in 1993 it grew rapidly and reached $2.9bn in revenue in its most recent fiscal year. And it did so with a business model that many had declared dead-on-arrival because its margins looked likely to be low. Red Hat takes free open-source software, makes some improvements, bundles it with other tools and services such as technical support and quality control, and charges a monthly subscription fee for the package.
Red Hat’s first product was a version of Linux, the operating system that now powers many servers in data centres and also most cloud-computing systems. It later acquired or developed more and more pieces of software that are needed to power computing clouds. One of the latest additions to its collection was OpenShift, a program that allows computing tasks to be easily moved around between servers and data centres, wrapped up in something called “containers”.
IBM, for its part, has been struggling in recent years to transform itself from a firm which made most of its money with IT services, software and mainframe computers to a company that is based on cloud computing, artificial intelligence (AI) and cyber-security products. After 22 consecutive quarters of declining revenue, IBM seemed to be over the worst when its turnover started to increase early this year. But in the most recent quarter, revenue dipped again, particularly in what IBM calls “strategic imperatives”, such as Watson, the firm’s brand of AI.
In the immediate future, the deal serves to change the prevailing narrative about IBM, which was increasingly seen as an IT has-been. It will probably also allow Ginni Rometty (pictured, right), the firm’s chief executive, to stay for a few years to see through the integration. Analysts thought she was on her way out, not just because her strategy seems to be failing, but because at 61, she is older than the standard retirement age for IBM bosses of 60.
But most importantly IBM hopes that it will give it a chance to catch up in the market of cloud computing, where it has fallen behind the big “public” clouds (as opposed to “private” ones, which only serve a particular company), in particular Amazon Web Services and Microsoft Azure, after it failed to take the trend seriously in the late 2000s and decided not to invest in a network of huge data centres. Red Hat’s OpenShift and Kubernetes, the underlying technology, are supposed to create an über-cloud, allowing computing workloads to run anywhere: whether it is in corporate data centres, on any of the big public clouds or a combination thereof (something called “hybrid cloud” and “multi-cloud”).
The question is whether the added flexibility of such mixed systems and the promise of not getting locked into any one vendor will be enough to lure firms onto IBM’s new platform. They could shy away from the additional complexity and prefer to put their data exclusively into the cloud. Microsoft, for instance, offers similar “hybrid cloud” systems, as do Dell and Hewlett Packard Enterprise (HPE), two other IT incumbents.
The merger, which is the largest in IBM’s history, could go wrong for other reasons—which, in addition to the high price tag, explains why the firm’s share price fell by 5% the day after the deal was announced (the company also said that it would cancel share buybacks, of which it has made generous use in recent years to prop up its shares). In particular, there could be a cultural clash between its still relatively strait-laced culture and Red Hat’s freewheeling one; ties are no longer de rigueur at IBM, but suits are, whereas at Red Hat’s headquarters in Raleigh, a day’s drive from IBM’S base in Armonk, it is not unusual to see employees wearing shorts (though no red hats). To avoid this, Red Hat will remain a “distinct unit”, as IBM puts it.
Further bidders seem unlikely, not just because of the high price, but because other buyers, such as Dell or HPE, would make Red Hat’s role as a cloud Switzerland less credible. Antitrust concerns are unlikely to stand in the way of the deal closing.
And then there is the question of what the acquisition means for Watson, the much-promoted AI business, which has disappointed so far. Some have suggested that buying Red Hat could mean that IBM will turn away from Watson, instead focusing even more on cloud computing. Yet according to Arvind Krishna, who heads IBM’S hybrid cloud business, Red Hat’s software containers will be a perfect vehicle to deliver AI everywhere. The idea is that IBM’S cloud failure held Watson back; now, with the help of Red Hat, it has the chance to spread more widely.
However the merger plays out, it has already produced one big winner: open-source software, which is developed collectively by firms that benefit from it and also by volunteer programmers. Red Hat is the third multi-billion acquisition of an open-source firm this year after MuleSoft, bought by Salesforce for $6.5bn, and GitHub, taken over by Microsoft for $7.5bn. This is not bad for a type of code whose pioneers saw themselves as rebels fighting “evil” proprietary-software makers, in particular Microsoft, accusing them of first locking in their customers and then fleecing them. These origins are also the inspiration for Red Hat’s name, Bob Young, the company’s co-founder, once explained: 18th-century revolutionaries both in America and France wore red caps during their uprisings.