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IBM Stock: It’s All About Red Hat

Enterprise software has been one of the most notable bright spots in the tech world. Just look at some of the recent IPOs which have soared in value from companies like Zoom Video Communications (NASDAQ:ZM) and Elastic (NYSE:ESTC) But even mature firms, like Microsoft (NASDAQ:MSFT) and Adobe (NASDAQ:ADBE), have rejuvenated their businesses.

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And then there is IBM (NYSE:IBM). The company whiffed on the cloud. It also whiffed on mobile. And even in AI (artificial intelligence) – in which IBM has invested for a  long time – the results have been mixed.

The irony is that IBM should have been a huge beneficiary of these trends. It has a trusted brand, a global footprint (it has 60 datacenters across the world) and a massive customer base. But unfortunately, the company did not adapt quickly enough.

The Good News for IBM Stock

Despite all its problems, IBM is still healthy from a financial standpoint, as it continues to generate substantial cash flows. The company also has incredibly talented employees.

More importantly for IBM stock, the company has made critical moves to restructure its operations. Specifically, it has eliminated jobs and unloaded non-core assets, while also retooling its software to keep up with the competition.

But I think the most consequential point is that the company has been willing to make big bets, as shown by its $34 billion mega-acquisition of Red Hat.

True, there is a good deal of irony in this deal. When Linux and other open-source software platforms emerged in the 1990s, IBM’s reaction was to fight back – and hard.

But it was a losing battle. Open-source software has become a critical part of companies’ arsenals. So with the Red Hat deal, IBM has become the leader of the space.

There are clear benefits to open-source software. Specifically,  adoption of it can be rapid because the technology is free and it’s continuously being updated by developers.

Red Hat has been able to leverage its technology to create an extensive platform that enables a hybrid cloud environment. Because of security, privacy and regulatory concerns, larger companies need to combine different, i.e. hybrid, options when it comes to the cloud. For example, they can utilize a mix of private and public clouds. Among the companies that provide public cloud infrastructure are Amazon (NASDAQ:AMZN), Alphabet (NASDAQ:GOOGL, NASDAQ:GOOG) and MSFT. As a result of this need for flexibility, the flexibility of the open-source model, for the most part, has proven to be spot-on.

As part of IBM, Red Hat will benefit from the tech giant’s tremendous distribution capabilities. What’s more, the cloud opportunity is still massive. IBM believes that the typical enterprise has only transitioned 20% of its data  to the cloud.

Here’s what the Senior Vice President and Chief Analyst of research firm IDC , Frank Gens, said about the acquisition of Red Hat: “As organizations seek to increase their pace of innovation to stay competitive, they are looking to open source and a distributed cloud environment to enable a new wave of digital innovation that wasn’t possible before. Over the next five years, IDC expects enterprises to invest heavily in their journeys to the cloud, and innovation on it. A large and increasing portion of this investment will be on open hybrid and multicloud environments that enable them to move apps, data and workloads across different environments.”

In other words, the deal has the potential to generate growth for IBM and should help make Big Blue a major player in cloud computing. That should definitely be positive for IBM stock.

The Bottom Line On International Business Machines Stock

I can understand why there is lots of skepticism regarding the bull case on IBM stock. Consider that, over the past five years, IBM stock price has fallen 2%.

But I think the Red Hat deal will be a game changer that will get IBM stock back on track. In fact, investors are already more upbeat on the shares, as IBM stock price has  jumped 25% this year.

There will likely be bumps in the road for IBM stock, as acquisitions are never easy. But with the dividend yield at 4.56% – one of the highest in the tech world – and the forward price-earnings ratio standing at only 10.5, IBM does look interesting.

Tom Taulli is the author of the book, Artificial Intelligence Basics: A Non-Technical IntroductionFollow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2019/09/ibm-stock-its-all-about-red-hat/.

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