IBM Pays $34 Billion for Red Hat, Which Made $258 Million Last Year

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There are several wild things about the International Business Machines Corp. (NYSE: IBM) buyout of cloud company Red Hat Inc. (NYSE: RHT). Among them is that IBM will pay $34 billion for a company that made $258 million last year on revenue of $2.9 billion.

IBM has offered an eye-popping 68% premium for Red Hat shares. At $190 a share, that is higher than Red Hat shares have ever traded. And Wall Street has not been kind to Red Hat recently. Its stock is down 17% in the past three months, a sign investors are worried about its future.

When Red Hat released its most recent quarterly statement, revenue was less than consensus estimates, while earnings were above them. Net income actually fell year over year to $87 million from $97 million. The company’s forecast for the fiscal year was lackluster:

Revenue is expected to be approximately $3.360 billion to $3.395 billion in USD.
GAAP operating margin is expected to be approximately 16.4% and non-GAAP operating margin is expected to be approximately 23.9%.

At the low end of guidance, revenue would be up only 15% year over year.

Red Hat also has poor margins. Last quarter, they were 11%.

The IBM buyout of Red Hat was what IBM called “strategic.” It only deserves that label if it brings something more to IBM than a new business and a modest new set of customers. Announcing the deal, Ginni Rometty, IBM’s board chair, president and chief executive officer, said:

The acquisition of Red Hat is a game-changer. It changes everything about the cloud market. 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.

If the deal does all that when IBM is buying a company that made $258 million last year, every other large cloud company completely missed the boat. That is unlikely.