Here’s Why Red Hat Is the Perfect Catalyst for IBM Stock

Although one of the established giants of technology, International Business Machines (NYSE:IBM) has largely stayed in the background. However, a recent news item brought IBM stock to the limelight. Last month, “Big Blue” closed its $34 billion acquisition of Red Hat. An open-source cloud solutions provider, Red Hat brings legitimacy to IBM’s broader digitalization ambitions.

IBM Stock Stronger as Red Hat Adds Fuel for Trillion-Dollar Opportunity
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That said, neither the markets nor many analysts have demonstrated positive sentiment toward the deal. For one thing, nothing that management forwarded has stuck in terms of the IBM stock price. Over the trailing five-year period, shares are down 25%. Naturally, this trend doesn’t inspire confidence. As a counterpoint, the vanilla SPDR S&P 500 ETF (NYSEARCA:SPY) is up over 50% during the same period.

Moreover, analysts have a ready explanation for the historical disappointment in International Business Machines stock. Our own Vince Martin concedes that the Red Hat buyout allows IBM the potential to compete with Amazon (NASDAQ:AMZN) and Microsoft (NASDAQ:MSFT) in the cloud. However, Martin gets tripped up about the cost.

As he articulated, $34 billion is a “whopping” sum for Red Hat. The fiscal impact to IBM stock means that it will pressure free cash flow. Thus, the acquired company must start delivering the goods. Otherwise, core selling points for International Business Machines stock, such as its 4.31% dividend yield, may take a hit.

I appreciate Martin’s argument because it’s a cautionary tale all prospective buyers should consider. At the same time, I respectfully take a more optimistic approach to IBM stock. Ultimately, the Red Hat deal provides the technical credibility that IBM has sought for years.

Red Hat Fills the Cloud Gap for IBM Stock

Before we dive into the bull case for International Business Machines stock, let’s first consider why Red Hat is so important for Big Blue. Red Hat president and CEO Jim Whitehurst had this to say:

When we talk to customers, their challenges are clear: They need to move faster and differentiate through technology. They want to build more collaborative cultures, and they need solutions that give them the flexibility to build and deploy any app or workload, anywhere.

To no surprise, Whitehurst’s comments echo IBM CEO Ginni Rometty’s motive for the buyout. Essentially, businesses are migrating over to the cloud en masse. Moreover, cloud solutions and technologies are constantly changing. As a result, IBM needs a naturally evolving catalyst to keep their cloud platform relevant.

Red Hat’s open-source innovations do exactly that. When client needs evolve – and they absolutely will – Red Hat evolves with them. Thus, it’s not just the deal’s front-facing costs you should consider when analyzing the IBM stock price. Instead, it’s what the acquisition offers five to ten years down the line. Based on the accelerative nature of technology, a lot can change over that span.

A few months ago, I had the opportunity to sit down with IBM Cloud general manager Jim Comfort and corporate communications representative Melinda Zurich. Comfort emphasized that IBM’s primary role is to help their clients transform their capabilities with digitalization.

In other words, companies are no longer impressed with merely storing data on the cloud. As the nature of the 21st century business environment changes, so too does individual demands. We’re not just talking about speed, but a comprehensive, scalable and adaptable solution. In this context, IBM offers a competent and credible pathway; hence, I’m optimistic long term about the IBM stock price.

Red Hat Also Fills the Cloud’s Education Gap

One of the biggest takeaways I received from my conversation with Comfort and Zurich is that the cloud has an education gap. This isn’t related specifically to IBM. However, a lack of awareness about the cloud’s details and intricacies have hurt the IBM stock price.

However, the Red Hat deal closes that gap in two ways. First, IBM now levers a comprehensive cloud product that adapts to their corporate clients’ needs. Second, “Big Blue” also has a viable PR case to make: their solutions are in many cases economically superior to rival offerings.

Here’s a dirty little secret about popular cloud platforms like AWS: they’re not as cost-effective as you might think. For example, many businesses have not efficiently set up their cloud infrastructures. That leads to many   associated with mundane tasks, such as data transfers.

But these costs add up. Eventually, such inefficiencies may overwhelm a company’s budget.

This is one of the bullish arguments for the IBM stock price that very few analysts are talking about. On the initial setup, AWS may be cheaper. But under the context of longer-term, scalable infrastructures, you’re probably better off going with a comprehensive outfit like IBM Cloud.

Again, that’s what Red Hat brings to the table. It’s not just their capacities. Rather, Red Hat potentially drives more budgetary transparency to the cloud migration. Thus, clients are able to make more informed decisions, which should spark revenue opportunities.

Of course, $34 billion is expensive, but only in the immediate context. If IBM successfully completes its recovery, that sum would be considered a bargain.

As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.

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