Big Blue is donning a new Red Hat, and one that makes a bold statement. The $34 billion acquisition of the open source technology firm is not only the biggest deal in IBM’s 107-year history but the largest software mergers and acquisitions (M&A) deal of all time.
At the heart of the deal is cloud computing: when data is processed, managed and stored on vast networks of remote servers rather than on computers or on-site data centres. It is at the core of the digital transformation occurring round the world and involves companies moving the growing amounts of data and IT applications from their internal and purpose-built networks to shared computing systems. By doing this, firms can outsource elements of IT to those that specialise in increasingly complex areas like data analysis and scale up digital operations quicker by leveraging the cloud provider’s powerful computing power and cheaper by avoiding the cost of installing expensive internal hardware.
Read more: IBM to revolutionise cloud with $34 billion Red Hat deal
IBM has built a formidable cloud computing unit that generated over $17 billion in revenue last year but it remains a distant third in the market behind Amazon and Microsoft, both of which continue to dominate and heighten their duopoly. IBM’s success has come down to selling the big mainframes that companies used to store and process their digital businesses on-site alongside the IT support and software that comes along with it but it has struggled to make the move to cloud computing and artificial intelligence compared to its peers. Its focus has so far been on hosting ‘private’ clouds designed for individual companies but IBM has lagged behind when it comes to the ‘public’ clouds that are industries are moving to.
Read more: What you need to know about Amazon’s Q3 results
A less-than-ideal rate of adoption has been partly down to the IBM’s distaste for large acquisitions. IBM’s biggest-ever deal was over a decade ago when it bought Cognos for $5 billion, but that record has been smashed with the acquisition of Red Hat. The size and ambition of the deal is even more poignant considering rivals are rapidly swallowing up both innovative tech startups and larger firms. Earlier this year Microsoft bought open source hosting company GitHub for $7.5 billion and Salesforce snapped up software platform provider Mulesoft for $6.5 billion.
Read more: Microsoft’s earnings and revenue beat forecasts
The combination of IBM and Red Hat, bringing together the expertise of the old with the innovation of the new, 'changes everything about the cloud market', according to the pair. But how does Red Hat work, why is IBM buying it and what does it mean for the future of Big Blue and cloud computing?
What does Red Hat do and how does it make money?
Red Hat, founded in 1993, improves open source software and combines it with important add-ons to help it work for businesses and consumers, such as technical support. Having originally found success by launching its own version of the Linux operating system – software that manages all of the hardware resources like Windows XP or Mac OS X – it is now the largest provider of open source software in the world. Those that want to access Red Hat’s package of products pay subscription fees, which helped push revenue up by more than one-third over the last three years to $2.9 billion in 2017.
What is open source software?
Open source software can be modified and enhanced by anyone. It is based around opening up access to the source code that forms the backbone of any software so others can build their own applications and uses for it. Although some open source software is only available to those willing to pay a licence fee, the vast majority is accessible for free by simply downloading it.
Open source has flung open the door to software applications and encouraged a more collaborative approach to development compared to proprietary software, which is owned by one company that allows others to use the software but not modify it. Open source allows developers around the world to improve existing software and build new applications using the same tools to make them all work with one another. This is a more cost-effective approach and faster way to develop software compared to containing development in-house and keeping the source code a closely guarded secret.
IBM could disturb collaboration in open source with Red Hat buy
IBM has been working with Red Hat for two decades and invested $1 billion in Linux back in 2001. The company is no stranger to open source and adopted the Linux operating system for its servers and software, helping thrust Linux into the market. But, while IBM’s contribution is well noted, one of the underlying principles of open source software and reasons why companies like Red Hat have thrived is the independence from the traditional corporate IT behemoths behind the proprietary software that many now regard to be a backward approach to development and one centred on greed.
This potential culture clash has even been recognised by Ginni Rometty, IBM’s chief executive who - after seven years in charge - has placed the big bet on tapping into Red Hat’s open source capabilities and community. Rometty has vowed to keep Red Hat independent as a distinct part of the business, stating IBM was 'going to preserve this Switzerland'.
The takeover could also irk its rivals that have partnered with Red Hat both as customers and in development. Open source has won over even the largest players and blurred the line between friend and foe in the market. Red Hat, having rolled-out new technologies in search of new growth as its Linux business matures (although IBM states its still the fastest-growing operating system in the market), has developed a technology framework named OpenShift that is at the core of IBM’s future strategy based around the ‘hybrid cloud’. But OpenShift is run with the help of platforms owned by IBM’s rivals such as Microsoft and Oracle.
Collaboration is only growing amid the rise of open source and decentralised technologies like blockchain, but some fear this could change as the big traditional players start to take control. It is possible companies like Microsoft could stop providing the critical support to OpenShift if it decides it no longer wants to support technology owned by one of its biggest rivals. While joint development is rife all over the industry and unlikely to come to an end some are worried the space will become more competitive as smaller firms are swallowed up by the traditional players, reducing their willingness to collaborate with one another. The same goes for their willingness to use the open source software if it is owned by a competitor.
Read more: Investing in blockchain technology
While companies like Red Hat - whose name is based on the red hats worn by liberators that challenge authority in society - have proven to be effective intermediaries and crucial partners to the traditional giants, the takeover of IBM and other deals this year are seeing the open source networks fall into the hands of those they were created to defy.
Why are IBM and Red Hat merging?
In a nutshell: IBM is looking to use Red Hat’s open source technology to improve its competitiveness in the cloud computing market after falling way behind market leaders Amazon and Microsoft, while Red Hat will be able to leverage IBM’s resources to scale up faster and access Big Blue’s longstanding corporate clients.
IBM is four times larger in terms of market cap and generates 27 times more revenue and pretax profit than Red Hat, but has struggled to grow both revenue and profitability. Meanwhile, Red Hat has been delivering double-digit growth in revenue across all its major segments.