IBM Stock Forecast: Red Hat Acquisition to Boost Cloud Revenue?

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IBM Takes a Significant Step to Lead in Hybrid Cloud

International Business Machines Corp. (NYSE:IBM) announced on October 28 that it’s acquiring Red Hat Inc (NYSE:RHT), the world’s leading provider of open-source cloud software.

IBM is set to acquire the Red Hat for $190.00 per share in cash, representing a total enterprise value of about $34.0 billion. (Source: “IBM To Acquire Red Hat, Completely Changing The Cloud Landscape And Becoming World’s #1 Hybrid Cloud Provider,” IBM Corporation, October 28, 2018.)

Red Hat, mainly known for its “Red Hat Enterprise Linux” operating system, has had a long-standing partnership with IBM, which has been a user of—and contributor to—Linux and other open-source projects.

IBM stock has nosedived following the news. Although this acquisition looks like the right step toward strengthening its position in the high-potential cloud space, the company has not been able to impress the market with its growth numbers as of late.

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IBM reported weaker-than-expected results in its most recent quarterly earnings update. The results in various business segments were not very impressive.

IBM’s “Cognitive Solutions” segment, which includes IBM’s “Watson” artificial intelligence (AI) program, disappointed with a revenue fall of six percent. And the revenue from the company’s biggest segment, “Technology Services and Cloud Platforms,” was almost flat.

IBM stock tanked following these results. Although IBM is focused on AI and cloud computing, its growth is not fast enough to impress the stock market.

The Red Hat acquisition, however, has the potential to turn things around. But that process is most likely to be a long and arduous journey, which could mean more pressure on IBM stock.

With the Red Hat deal, IBM could become a leading global player in the hybrid cloud market, which is an emerging $1.0-trillion growth market. But, as with the company’s overall turnaround efforts, it will take some time for the results to show.

Hybrid cloud technology is a combination of a private cloud with a public one.

IBM management stated in its press release that the Red Hat deal will add to the company’s free cash flow and gross margin within 12 months, as well as offer accelerated revenue growth.

The deal is significant, since cloud computing has become a major growth contributor to IBM, which has been struggling in recent years to transform itself. IBM still lags behind the major cloud players like Amazon.com, Inc. (NASDAQ:AMZN), Microsoft Corporation (NASDAQ:MSFT), and Alphabet Inc (NASDAQ:GOOG).

“The acquisition of Red Hat is a game-changer. It changes everything about the cloud market,” said IBM’s Chairman, President, and CEO Ginni Rometty. “IBM will become the world’s #1 hybrid cloud provider, offering companies the only open cloud solution that will unlock the full value of the cloud for their businesses.” (Source: Ibid.)

IBM stock has been on a downward journey, already losing 15% over the last year, as the following stock chart shows:

IBM Stock Chart

Chart courtesy of StockCharts.com

The company’s turnaround efforts are taking a long time, and the results have been below expectations. This does not bode well for IBM stock.

Analyst Take

IBM has been investing to become a key player in the emerging, high-value segments of the IT industry. Its Red Hat acquisition is the company’s largest move as part of that high-value strategy.

The deal has the potential to shake up the multi-billion-dollar cloud infrastructure market, and it will help IBM compete with the giants in the industry.

However, it will take time before that stage is reached. IBM will have to show better financial results in the subsequent quarters in order to instill confidence in the investor community. Hence, caution is advised and investors might want to wait and watch IBM stock for now.