IBM Announces Acquisition of Red Hat
We are lowering our fair value estimate for the narrow-moat firm and think shares remain undervalued.
IBM (IBM) announced that it had reached a definitive agreement to acquire Red Hat for $190 per share, or $34 billion in enterprise value. We expect the deal to be funded through a mixture of cash and debt while IBM also suspends its stock buyback program for fiscal 2020 and 2021. We see some strategic rationale in favor of IBM's planned acquisition and believe there can be scale-related revenue synergies based on cross-selling opportunities. However, we think IBM has been backed into this position and needed an acquisition of this magnitude and nature to reinvigorate its growth profile and competitive positioning after years of lagging performance versus peers. As the world becomes increasingly cloud-focused, the hybrid cloud boost IBM will receive from the Red Hat acquisition will be supportive and at least give IBM a fighting chance against other cloud providers. We see Red Hat as an open-source sales catalyst for IBM across its own (and competitors) infrastructure-as-a-service, platform-as-a-service, and hosted private cloud environments, but still see IBM as an also-ran versus peers in the infrastructure and platform markets. After incorporating the acquisition into our model, we are lowering our fair value estimate for narrow-moat IBM to $158 per share from $168, as we're concerned about whether IBM will extract enough revenue synergies to justify the deal price. Nonetheless, IBM's shares remain undervalued, in our view.
In terms of the financial aspects of the deal, we view a 63% premium as a bit high compared with recent software deals and above our $145 fair value estimate for narrow-moat Red Hat. The deal is expected to close in the second half of 2019, and we do not foresee any regulatory hurdles. Rumors suggest that IaaS leaders like Microsoft, Google, or Amazon may try to outbid IBM for Red Hat, but we suspect that Red Hat's Enterprise Linux (RHEL) operating system is best served under IBM’s mammoth services divisions.
|Morningstar Premium Members gain exclusive access to our full analyst reports, including fair value estimates, bull and bear breakdowns, and risk analyses. Not a Premium Member? Get this and other reports immediately when you try Morningstar Premium free for 14 days.|
Andrew Lange does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.
Transparency is how we protect the integrity of our work and keep empowering investors to achieve their goals and dreams. And we have unwavering standards for how we keep that integrity intact, from our research and data to our policies on content and your personal data.
We’d like to share more about how we work and what drives our day-to-day business.
We sell different types of products and services to both investment professionals and individual investors. These products and services are usually sold through license agreements or subscriptions. Our investment management business generates asset-based fees, which are calculated as a percentage of assets under management. We also sell both admissions and sponsorship packages for our investment conferences and advertising on our websites and newsletters.
How we use your information depends on the product and service that you use and your relationship with us. We may use it to:
To learn more about how we handle and protect your data, visit our privacy center.
Maintaining independence and editorial freedom is essential to our mission of empowering investor success. We provide a platform for our authors to report on investments fairly, accurately, and from the investor’s point of view. We also respect individual opinions––they represent the unvarnished thinking of our people and exacting analysis of our research processes. Our authors can publish views that we may or may not agree with, but they show their work, distinguish facts from opinions, and make sure their analysis is clear and in no way misleading or deceptive.
To further protect the integrity of our editorial content, we keep a strict separation between our sales teams and authors to remove any pressure or influence on our analyses and research.
Read our editorial policy to learn more about our process.