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So IBM buys Red Hat for $34B, of which $20B are borrowed monies. The debt is priced at 1.05 percentage points above Treasury yield rate [1] which would be somew

So IBM buys Red Hat for $34B, of which $20B are borrowed monies. The debt is priced at 1.05 percentage points above Treasury yield rate [1] which would be somewhere around 3.5% which puts interest on bond debt at ~$700m every year. Now consider that Red Hat had a net income of $433m. Even if they reach $500 this year, Big Blue will still be $200m short, every year. At the moment, IBM is trading down at -0.5% on an otherwise slight green Nasdaq. Just from these numbers we can conclude that IBM is seeing some pretty significant synergies in the purchase that the market isn't. [1] https://www.barrons.com/articles/ibm-bond-sale-red-hat-51557347372 https://www.barrons.com/articles/ibm-bond-sale-red-hat-51557...

asdf21 7y ago
>Now consider that Red Hat had a net income of $433m. I wonder how much of that is from IBM anyway..
jsight 7y ago
Free cash flow may be the more important metric for this purpose. I believe it is closer to $1B/year and presumably growing?
jcampbell1 7y ago
You need to add back income taxes of about $80M, so they are only $120M short. Interest expense is pre-tax.
coliveira 7y ago
But IBM bought RH only because they believed that the company has growth ahead. If it grows a little more than 1% a year (which should be easy) that will be enough to break even. I think that was a smart move by IBM.
- colinmhayes 7y ago
  You are forgetting about the opportunity cost of $34 billion.
  - coliveira 7y ago
    This is money used to buy large corporations, there are no other ways IBM could easily find a loan to spend $34B.
- aksss 7y ago
  I remember someone pretty savvy once rhetorically asking why companies are always doing M&A's that seem questionable from ground level. She said because it's more fun to buy things than doing the real work of cleaning up your own company model and performance. There's some sobering truth to that explanation of corporate behavior. The illusion of growth and progress and the thrill of the acquisition can be a good short-term anesthetic. I tend to think IBM is a bit more deliberate than that, however.
- johnvanommen 7y ago
  > I think that was a smart move by IBM. I wish Microsoft had purchased Red Hat, that would offer real synergy: 1) Microsoft could contribute to Ansible 2) Microsoft would control licensing for RHEL on Azure 3) We might see Outlook and Office running on RHEL. Or even Direct3D?
axplusb 7y ago
Red Hat net income is growing pretty consistently though [0]. With this price for debt, IBM could be cash-flow positive on this deal within a couple of years even without any big synergy, just by the simple effect of cumulated growth on (net) income. [0] https://www.macrotrends.net/stocks/charts/RHT/red-hat/net-income https://www.macrotrends.net/stocks/charts/RHT/red-hat/net-in...
jedimastert 7y ago
I like your analysis. One thing that may be missing is how much money flows between them.
- iNate2000 7y ago
  Like, existing deals, you mean?
  - jedimastert 7y ago
    Yeah, like if there's a contract between them or a regular amount of spending, that's an amount of money that IBM's saving each year, but that's also money that RedHat won't be earning each year. I don't know how important, percentage-wise, that number would be for either side. I imagine any amount of money would be a far bigger deal for RedHat than IBM.
    - aksss 7y ago
      Well, it's a bit like renting an apartment vs paying down a mortgage, right? On the books they (IBM) will almost certainly still be paying the subsidiary (RH), and the subsidiary will still record and report the revenue. But IBM is now building equity with its payments up at the consolidated reporting level rather than shoveling the cash out the window.
vikramkr 7y ago
That assumes zero growth, I think ibm obviously expects revenues and income to grow from red hat over time which would justify the purchase price. Whether or not that's warranted it's a different story, but the entirely of the price justification is probably not synergies - the cloud sector is growing pretty fast in general
Voloskaya 7y ago
> Just from these numbers we can conclude that IBM is seeing some pretty significant synergies in the purchase that the market isn't. Or there was basically very little chance that the acquisition wouldn't go through, and since we have known about it for months, it is already priced in the current stock value of IBM, so today's trading would be mostly unrelated and not representative of what investors think about the purchase.
- vpribish 7y ago
  exactly. the impact from the deal mostly happened at its announcement October 29, 2018 when IBM fell about 5% on the news.
  - bonzini 7y ago
    Which in turn can be explained by a decrease in buybacks and/or dividends and thus by lower expected ROI.
    - KUcxrAVrtI 7y ago
      Or more likely that IBM has been screwing the pooch every which way for the last ~~20~~ 30 years.
      - bdcravens 7y ago
        That doesn't bode well for Red Hat over the long term.
        bmurphy1976 7y ago
        Unless Red Hat cannibalizes IBM from the inside out, and there's some talk that this is exactly what they want. They may be grooming Red Hat's CEO to replace IBM's CEO.
        KUcxrAVrtI 7y ago
jedberg 7y ago
The acquisition was most likely already priced in, but I think the synergy IBM is hoping for is that they are really really good at selling to the enterprise. They have one of the most successful enterprise technology sales teams in the world. I suspect that just making RedHat's enterprise sales more efficient will be enough to boost sales.
Spooky23 7y ago
Red Hat is an incredibly valuable property that didn't sell aggressively enough. Just by pushing on it's customer base, IBM will make alot of money on Red Hat, both with new business and blowing up legacy junk at IBM.
adamredwoods 7y ago
Debt is reduced when inflation goes up. Perhaps they are predicting inflation?
rolltiide 7y ago
Red Hat control and discretion and non-revenue generating properties now belong to IBM. The purchase multiple is pretty crazy, and I like that I can point to a multiple that high when suitors want to buy into my own tech companies. But for IBM this is a net win. Paying all that interest is basically a rounding error and means they barely spent any money for decades if they so choose.
formercoder 7y ago
Let's not confuse accounting earnings with cash flows. Red Hat is generating a decent amount of cash ~1B in cash from operations (difference from 433M mostly due to stock based comp and deferred revenue, common for software companies). I didn't look into the details of the deal but IIRC $34B is the enterprise value, so it probably includes a refinancing of Red Hat's debt. RH had ~20M in interest last year, so you can take that off of the 700M. So now we're talking about 680M in marginal interest expense on a firm with ~950M in pre-transaction free cash flow to equity. Not to mention RH's 65% top line growth in 2018, we'll see if that happens again. This transaction could be cash flow positive right off the bat. Also Red Hat is operating at an ~18% ebitda margin (did not go looking for add backs), I'm assuming IBM can get that up. Of course, it's easy to imagine IBM just torching all of Red Hat's top line... can't rule that out.
tracker1 7y ago
I think that RedHat itself and the investments in CoreOS and other tech used in OpenStack is a pretty big thing for tethering in IBM. I think it's a better fit than, for contrast, Oracle. I do hope that the RH of old and some of the other bits remain Open Source friendly.

asdf21 7y ago

>Now consider that Red Hat had a net income of $433m. I wonder how much of that is from IBM anyway..

jsight 7y ago

Free cash flow may be the more important metric for this purpose. I believe it is closer to $1B/year and presumably growing?

jcampbell1 7y ago

You need to add back income taxes of about $80M, so they are only $120M short. Interest expense is pre-tax.

coliveira 7y ago

But IBM bought RH only because they believed that the company has growth ahead. If it grows a little more than 1% a year (which should be easy) that will be enough to break even. I think that was a smart move by IBM.

colinmhayes 7y ago
You are forgetting about the opportunity cost of $34 billion.
- coliveira 7y ago
  This is money used to buy large corporations, there are no other ways IBM could easily find a loan to spend $34B.
aksss 7y ago
I remember someone pretty savvy once rhetorically asking why companies are always doing M&A's that seem questionable from ground level. She said because it's more fun to buy things than doing the real work of cleaning up your own company model and performance. There's some sobering truth to that explanation of corporate behavior. The illusion of growth and progress and the thrill of the acquisition can be a good short-term anesthetic. I tend to think IBM is a bit more deliberate than that, however.
johnvanommen 7y ago
> I think that was a smart move by IBM. I wish Microsoft had purchased Red Hat, that would offer real synergy: 1) Microsoft could contribute to Ansible 2) Microsoft would control licensing for RHEL on Azure 3) We might see Outlook and Office running on RHEL. Or even Direct3D?

axplusb 7y ago

Red Hat net income is growing pretty consistently though [0]. With this price for debt, IBM could be cash-flow positive on this deal within a couple of years even without any big synergy, just by the simple effect of cumulated growth on (net) income. [0] https://www.macrotrends.net/stocks/charts/RHT/red-hat/net-income https://www.macrotrends.net/stocks/charts/RHT/red-hat/net-in...

jedimastert 7y ago

I like your analysis. One thing that may be missing is how much money flows between them.

iNate2000 7y ago
Like, existing deals, you mean?
- jedimastert 7y ago
  Yeah, like if there's a contract between them or a regular amount of spending, that's an amount of money that IBM's saving each year, but that's also money that RedHat won't be earning each year. I don't know how important, percentage-wise, that number would be for either side. I imagine any amount of money would be a far bigger deal for RedHat than IBM.
  - aksss 7y ago
    Well, it's a bit like renting an apartment vs paying down a mortgage, right? On the books they (IBM) will almost certainly still be paying the subsidiary (RH), and the subsidiary will still record and report the revenue. But IBM is now building equity with its payments up at the consolidated reporting level rather than shoveling the cash out the window.

vikramkr 7y ago

That assumes zero growth, I think ibm obviously expects revenues and income to grow from red hat over time which would justify the purchase price. Whether or not that's warranted it's a different story, but the entirely of the price justification is probably not synergies - the cloud sector is growing pretty fast in general

Voloskaya 7y ago

> Just from these numbers we can conclude that IBM is seeing some pretty significant synergies in the purchase that the market isn't. Or there was basically very little chance that the acquisition wouldn't go through, and since we have known about it for months, it is already priced in the current stock value of IBM, so today's trading would be mostly unrelated and not representative of what investors think about the purchase.

vpribish 7y ago
exactly. the impact from the deal mostly happened at its announcement October 29, 2018 when IBM fell about 5% on the news.
- bonzini 7y ago
  Which in turn can be explained by a decrease in buybacks and/or dividends and thus by lower expected ROI.
  - KUcxrAVrtI 7y ago
    Or more likely that IBM has been screwing the pooch every which way for the last ~~20~~ 30 years.
    - bdcravens 7y ago
      That doesn't bode well for Red Hat over the long term.
      - bmurphy1976 7y ago
        Unless Red Hat cannibalizes IBM from the inside out, and there's some talk that this is exactly what they want. They may be grooming Red Hat's CEO to replace IBM's CEO.
        KUcxrAVrtI 7y ago

jedberg 7y ago

The acquisition was most likely already priced in, but I think the synergy IBM is hoping for is that they are really really good at selling to the enterprise. They have one of the most successful enterprise technology sales teams in the world. I suspect that just making RedHat's enterprise sales more efficient will be enough to boost sales.

Spooky23 7y ago

Red Hat is an incredibly valuable property that didn't sell aggressively enough. Just by pushing on it's customer base, IBM will make alot of money on Red Hat, both with new business and blowing up legacy junk at IBM.

adamredwoods 7y ago

Debt is reduced when inflation goes up. Perhaps they are predicting inflation?

rolltiide 7y ago

Red Hat control and discretion and non-revenue generating properties now belong to IBM. The purchase multiple is pretty crazy, and I like that I can point to a multiple that high when suitors want to buy into my own tech companies. But for IBM this is a net win. Paying all that interest is basically a rounding error and means they barely spent any money for decades if they so choose.

formercoder 7y ago

Let's not confuse accounting earnings with cash flows. Red Hat is generating a decent amount of cash ~1B in cash from operations (difference from 433M mostly due to stock based comp and deferred revenue, common for software companies). I didn't look into the details of the deal but IIRC $34B is the enterprise value, so it probably includes a refinancing of Red Hat's debt. RH had ~20M in interest last year, so you can take that off of the 700M. So now we're talking about 680M in marginal interest expense on a firm with ~950M in pre-transaction free cash flow to equity. Not to mention RH's 65% top line growth in 2018, we'll see if that happens again. This transaction could be cash flow positive right off the bat. Also Red Hat is operating at an ~18% ebitda margin (did not go looking for add backs), I'm assuming IBM can get that up. Of course, it's easy to imagine IBM just torching all of Red Hat's top line... can't rule that out.

tracker1 7y ago

I think that RedHat itself and the investments in CoreOS and other tech used in OpenStack is a pretty big thing for tethering in IBM. I think it's a better fit than, for contrast, Oracle. I do hope that the RH of old and some of the other bits remain Open Source friendly.