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

IBM Takes a Significant Step to Lead in Hybrid Cloud

International Business Machines Corporation (NYSE:IBM) announced Sunday that it would acquire Red Hat Inc (NYSE:RHT), the world’s leading provider of open-source cloud software.

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

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

IBM had reported weaker-than-expected results in its most recent quarterly earnings update. The results in various business segments were not that impressive. Cognitive solutions, which includes IBM’s “Watson” artificial intelligence (AI) program, disappointed with revenue fall of six percent. And the revenue from its biggest segment, Technology Services and Cloud Platforms, was almost flat.

IBM stock tanked following these results—results that don’t inspire confidence in the future growth potential of the company. Although IBM is focused on AI and cloud computing, the growth is not fast enough to impress the market.

However, the current deal has the potential to turn things around. But it is most likely to be a long and arduous journey, and this would mean more pressure on IBM stock.

With the Red Hat deal, IBM would 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 would take some time for the results to show.

Management also stated in its press release that the deal would add to the company’s free cash flow and gross margin within 12 months, as well as offer accelerate revenue growth.

The deal is significant, as the cloud has become a major growth contributor to IBM, which has been struggling in recent years to transform itself into a cloud computing company. It is still 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.)

Hybrid cloud is a combination of a private cloud with a public one. And companies would shift business applications to hybrid cloud to optimize every part of the business.

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

Chart courtesy of StockCharts.com

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

Analyst Take

IBM has been investing to be a key player in the emerging, high-value segments of the IT industry. The 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 would help IBM in competing with the giants in the industry.

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