What took you so long, Ginni?
That was my first reaction when I heard International Business Machines Corporation (IBM) was making a big strategic shift by purchasing open source cloud company Red Hat (RHT) in a landmark $34 billion deal.
Ginni Rometty, IBM’s CEO since 2012, has presided over persistent negative sales growth and has done zilch for investors to conjure up some type of lasting hope for this company.
Not only has Rometty failed to grow the top line, but with an underwhelming 3-year EPS growth rate of -2%, the execution and performance haven’t been there as well.
Somehow and someway, she has maintained an iron-clad grip on her job at the helm of IBM and her legacy at IBM will be wholly determined by the failure or success of this Red Hat acquisition.
IBM shares sold off on the news as shareholders digested this bombshell.
Rometty took a hatchet to share buybacks and suspended them for 2020 and 2021 alienating a segment of their loyal shareholder base.
I can tell you one thing about this move – it smells of desperation and it won’t vault IBM into the conversation of Amazon (AMZN) Web Services or the Microsoft (MSFT) Azure.
The biggest winner of this deal is Red Hat’s CEO Jim Whitehurst who has been dangling the company for sale for a while.
Alphabet (GOOGL) was in the mix and had the opportunity to snag a last-second deal, but it never came to fruition.
The 63% premium IBM must pay for a company who only grew quarterly sales 14% YOY and quarterly EPS by 10% is expensive, but that is where we are with IBM.
Clearly overpaying was better than doing nothing at all.
IBM continues to hemorrhage sales and stopping the blood flow is the first step.
Rometty was responsible for the utter failure of artificial intelligence initiative Watson whose terrible management was a key reason for its implosion.
Analyzing this historic company gave me insight into the pitiful causing me to write a bearish story on IBM last month. To read that story, please click here.
Not only was the agreed price exorbitant, but Red Hat’s stock was trending south even before the interest rate induced sell-off rocked the tech sector of late.
Red Hat missed on sales revenue forecasts and offered weak guidance.
It could be the case that Whitehurst was actively seeking a buyer because he felt that Red Hat would go ex-growth in the next few years.
Red Hat was rumored to be on the market for quite a while looking to fetch a premium price for a company starting to stagnate with its visions of grandeur growth.
Rometty’s career-defining moment is high-risk and high-reward and is born out of being cornered by leading tech companies leaving IBM in their dust.
The deal finally allows IBM to return back to sales growth which will occur two years later, and Rometty will finally have that monkey off her back for now.
But the bigger question is will Rometty still have her job in two years if this experiment becomes toxic.
My guess is that Red Hat CEO Jim Whitehurst is automatically the next in line for the IBM throne if Rometty missteps, and piling on pressure will force IBM to evolve or die out.
And even though they will return back to growth, 2% growth is no reason to do cartwheels over.
The real work starts now and it will take years to turn around this dinosaur.
On the brighter side, the massive deals instantly improve sentiment that was flagging for years and puts IBM back on the map.
The synergies between IBM and Red Hat could be robust.
Red Hat can surely help IBM become a higher-quality hybrid cloud solutions company.
Models like this are the industry standard as luring a company into your cloud is one thing, but being able to cross-sell a plethora of extra add-on software services in the cloud is the necessary path to raising profitability.
IBM also inherits a slew of talented software engineers that it can mobilize for innovative cloud products. Red Hat’s products such as JBoss middleware and the OpenShift software for deploying applications in virtual containers could make IBM’s hybrid cloud more appealing and could help retain customers with the additional offerings.
Doubling down on the software side of the business was a strategy I pinpointed at the Mad Hedge Lake Tahoe conference and deals like this highlight the value of this type of assets.
There is a hoard of legacy tech companies like Oracle (ORCL) that is in dire need of such strategic injections and fresh ideas.
This won’t be the last deal of 2018, other cloud deals could shortly follow.
On the other side of the coin, hardware deals have turned rotten quickly with stark examples such as Hewlett-Packard’s (HPQ) $25 billion acquisition of Compaq, Microsoft’s $7.2 billion disastrous buy of Nokia’s mobile handset business and Google’s unimpressive $12.5 billion deal for Motorola Mobility that they later unloaded to Chinese PC company Lenovo.
Investors must be patient if IBM has any chance of completing this turnaround.
Listening to Rometty talk about this deal clearly reveals that she is hyping it up for something way bigger than it actually is.
Let’s not forget that Rometty’s tenure as CEO began in 2012 when IBM shares were trading north of $200 and she has presided over the company while the stock got pulverized by almost 30%.
It pains me that she is the one given the chance to turn the company around after years of underperformance.
Let’s not forget that at the end of 2017, IBM only had a 1.9% share of the cloud infrastructure, about 25 times smaller than Amazon Web Services.
The costly nature of the deal could also put a dent into IBM’s dividend, alienating another swath of its hardcore shareholder base.
Historically, IBM has had minimal success with transformative M&A and the industry competitors dominating IBM magnify the poor management performance headed by Rometty.
Rometty declaring that this deal means IBM will be “no. 1 in hybrid cloud” is overly optimistic, but this is a move in the right direction and could keep IBM spiralling out of control.
A return to sales growth might help stem the bleeding of its downtrodden share price, but Amazon and Microsoft are too far ahead to catch.
Investors will need to wait and see if the synergies between IBM’s and Red Hat’s products are meaningful or not.
