The decision by International Business Machines (NYSE:IBM) to buy Red Hat (NYSE:RHT) for $34 billion is a loud acknowledgement that open source has beaten IBM’s proprietary business model. IBM says it will pay cash for Red Hat, meaning it will exhaust its cash reserves and take on over $20 billion in additional debt.
To Wall Street, this makes it all risky business. IBM shares dropped almost 3% in early trade Oct. 29, after the announcement, while Red Hat was remained $17 per share short of the deal’s $190 per share target price.
Open source advocates, including many Red Hat employees, are nervous about the deal. It also comes just weeks after Red Hat missed on revenue targets, and delivered a sour outlook that had sent shares down 12% within two weeks.
Clouds are Tools
Red Hat CEO Jim Whitehurst says open source clouds are like the standard screws and bolts that appeared in the early 19th century, 60 years into the Industrial Revolution. Standard parts let engineers design trains, planes and automobiles. But it wasn’t the Linux operating system that drove this deal, it was Whitehurst’s own decision to go all-in on cloud tools with OpenShift, an open source platform that adapts existing technologies (starting with Red Hat’s own middleware) to the cloud.
Open source, as a concept, had been fighting a two-decade-long war for acceptance against proprietary models like IBM’s own mainframes, the Oracle (NASDAQ:ORCL) database and Microsoft (NASDAQ:MSFT) Windows. Open source represents the high, and rising platform that both clouds and developers can build on, I wrote. The more eyes that are on the code, the more stable it can be, and the more competitive the resulting markets.
Red Hat Buying IBM?
Ever since its founding in 1915, IBM has been a sales-oriented business claiming to offer solutions to business problems — a succession of black boxes IBM insisted its engineers were best-equipped to understand.
So, while Red Hat was selling tools, IBM was offering “Watson,” a cloud front-end it insisted would deliver answers and solve problems. But Watson has proven an expensive failure, and in buying Red Hat IBM acknowledges this. I believe making Watson itself open source would be bullish for IBM stock.
What Red Hat employees and open source advocates fear is that IBM will force RHT stock to conform to “the IBM way.” But the two companies have been close allies for years, with IBM executives regularly keynoting Red Hat’s annual Summit conference.
It is troubling that Red Hat shareholders are getting no IBM equity in this deal, just cash. But Whitehurst insists Red Hat will continue to work with, and interoperate with, all of IBM’s public cloud rivals, including Microsoft Azure, Amazon (NASDAQ:AMZN) Web Services and Alphabet’s (NASDAQ:GOOG, NASDAQ:GOOGL) Google Cloud. Whitehurst also promised his employees that the company’s “open organization” leadership style will be brought to IBM, which has long been criticized for operating in a bureaucratic manner.
The Bottom Line for IBM Stock and Red Hat
If RHT stock fulfills its own promises to employees, it would transform IBM and turn it from my favorite sell to my favorite buy.
That is not yet certain.
If Whitehurst or his team start filtering out of IBM as the deal approaches fruition, I’d be a seller of IBM stock. If they win promotions — if Red Hat turns out to be acquiring IBM — buy with both hands.
Dana Blankenhorn is a financial and technology journalist. He is the author of a new mystery thriller, The Reluctant Detective Finds Her Family, available now at the Amazon Kindle store. Write him at email@example.com or follow him on Twitter at @danablankenhorn. As of this writing he owned shares in MSFT and AMZN.