IBM's Red Hat Acquisition: 'Management Has Run Out of Steam'

Mitch Wagner
News Analysis
Mitch Wagner, Executive Editor, Light Reading

With its $34 billion Red Hat acquisition, IBM is making a bold move to set a path for itself that's different from other hypercloud players.

In American football terms, it's a "hail mary" -- a long pass made in a desperate, and usually unsuccessful, attempt to score late in the game. (See IBM Buying Red Hat for $34B, Turning Cloud Upside Down.)

With the Red Hat Inc. (NYSE: RHT) acquisition, IBM Corp. (NYSE: IBM) abandons its unsuccessful strategy of being a public cloud trying to compete with Amazon, Microsoft and Google. (See Cloud Spending Growth Slows, While Big Providers Squeeze Little Guys Even Harder.)

IBM positions itself instead as a hybrid cloud platform, a trusted partner to help enterprises integrate their on-premises IT with the new era of the cloud containers and AI.

It's a great idea, articulated by IBM leadership several times since the two companies announced their surprise engagement Sunday afternoon. And IBM was talking up that strategy even before the merger announcement. (See Is IBM Late to the Multicloud Party?)

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However, Amazon, Google and especially Microsoft are also playing the hybrid, enterprise cloud game, as are Dell and VMware. So IBM isn't unique there. (See VMware & Amazon Grow Hybrid Tie-Up to 'Very Large Scale', Google Debuts On-Prem Kubernetes Server and Dell CTO: Public Cloud Is 'Way More Expensive Than Buying From Us'.)

And, furthermore, it's unclear why IBM needed to pay a staggering premium for Red Hat to change its strategy. Red Hat has strong technology, but so does IBM.

What Red Hat has that IBM lacks is agility, reflected in the two companies' respective growth rates. Red Hat is growing at a healthy clip, while IBM revenues are stagnating. (See Is IBM Overpaying for Red Hat?)

But Red Hat's agility may not help IBM. When a big, slow-moving company acquires a smaller, agile business, it's much easier for the big business to slow down the smaller acquisition than it is for the company being acquired to infuse its new parent with new life.

"My view is that IBM management has run out of steam with all marketing and buzz around 'strategic imperatives' -- an IBM marketing term highlighting all new technologies, such as cloud, AI, and blockchain," says Saurabh Sharma, Ovum Ltd. principal analyst for infrastructure solutions, in an email to Light Reading. "IBM Watson, IBM's flagship AI platform, is not delivering the kind of growth IBM leadership has expected and so they decided to pivot to hybrid cloud opportunity and Red Hat was the only one IBM could buy." (See Is IBM's Watson Overhyped & Soon to Be Outdone?)

"Color me more than a little skeptical," about the acquisition, says Roz Roseboro, Heavy Reading principal analyst for cloud infrastructure and management. "I worry about the culture fit. These two companies couldn't be any more opposite. The chances that Red Hat's DNA takes hold in a company as old and large as IBM are slim."

She continues, "IBM gets some halo effect from Red Hat and Red Hat gets the IBM machine behind them -- although I'm not convinced that's a good thing." Roseboro's impression of Red Hat is that "they have been humming along quite nicely;" although she does hear occasional grumbling about the company, she attributes that to sour grapes.

The differences between the two companies are stark, Sharma says.

"IBM and Red Hat are two different types of software vendors. IBM sells to CIOs and high-level IT directors." Red Hat, on the other hand, "relies on developers and hands-on technologists for its business," as a by-product of its open source focus.

"Red Hat is agile and has a good run in terms of revenue growth. It grew 20% and 21% respectively for financial years 2017 and 2018. IBM has had 20 straight quarters of revenue decline, and then some feeble growth for two quarters. The most recent quarterly results for IBM were below expectations." (See IBM Is Losing the Cloud Race.)

Next page: IBM will kill Red Hat's culture

With the Red Hat acquisition, IBM is targeting hybrid cloud, Sharma says. "It is not a leading vendor in the public cloud market, and by no means a competitor to AWS, Google and Microsoft, and has no intention to improve its positioning [in the public cloud market]," he says. "IBM's plan is to target hybrid cloud opportunities involving containers, open standards and Linux systems."

IBM claims the Red Hat acquisition "will enable it to help enterprises move to the cloud without getting locked into a proprietary technology stack," Sharma says.

Overall, Sharma expressed bafflement at the acquisition.

"For some reason, IBM believes that hybrid and private cloud opportunity will grow at comparable rates to the public cloud opportunity," he says. "What's still not clear is why IBM decided to buy a company, Red Hat, best known for distributing the open source Linux operating system, to win the hybrid cloud battle." Red Hat's cloud revenue is too small to "impart any serious thrust to IBM cloud ambitions," Sharma says.

"Though IBM has said that Red Hat will operate as a separate business unit under IBM's hybrid cloud business, with time I'd expect IBM to push against Red Hat's open source culture and focus on only revenues. Red Hat's engineering teams need to adapt to IBM's business-heavy bureaucratic culture. Not much original open source culture will remain, say, four to five years from now," Sharma says. (See IBM: Don't Panic! We Won't Mess With Red Hat.)

"The one good thing for Red Hat is that IBM's sales prowess will provide greater exposure, especially for multi-million-dollar deals involving top executive leadership." But IBM may have difficulty adapting to Red Hat's smaller deals targeting developers, and not normally running to millions of dollars, Sharma says.

IBM's Red Hat acquisition is an attempt by IBM to recapture its 1990s turnaround, under then-CEO Lew Gerstner, who took over a failing IBM in 1993 and rebuilt it as a business services company, helping enterprises navigate the then-new terrain of the Internet and e-commerce, says independent analyst Ben Thompson, writing at his website, Stratechery.

Other companies provided technology -- IBM provided "solutions" to solve business problems, Thompson says.

The problem with applying this strategy today is that Gerstner's successor, Sam Palmisano, failed to invest in public cloud infrastructure when he needed to, a decade ago; "indeed, one of the most important takeaways from the Red Hat acquisition is the admission that IBM's public cloud efforts are effectively dead," Thompson says.

Thompson adds: "This is the bet: While in the 1990s the complexity of the Internet made it difficult for businesses to go online, providing an opening for IBM to sell solutions, today IBM argues the reduction of cloud computing to three centralized providers makes businesses reluctant to commit to any one of them. IBM is betting it can again provide the solution, combining with Red Hat to build products that will seamlessly bridge private data centers and all of the public clouds."

The problem with this strategy is that enterprises then risk lock-in with IBM in their quest to avoid being locked in to Amazon, Microsoft or Google. And if Red Hat's openness protects enterprises against that problem, IBM's increasingly sophisticated customers can just use those open tools to build solutions themselves, Thompson says.

Moreover, Microsoft also specializes in hybrid solutions, but "because Microsoft has actually spent the money on infrastructure, their ability to extract money from the value chain is correspondingly higher." IBM has to "pay rent" to public cloud providers for infrastructure, where Microsoft has its own, Thompson says.

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