Mad Dog 21/21: Hat In Hand
December 10, 2018 Hesh Wiener
IBM’s acquisition of Red Hat is for Ginni Rometty as vital and significant as Lou Gerstner’s development of IBM’s services business in the 1990s. If IBM can properly integrate Red Hat, IBM’s legacy businesses and strategic initiatives will all be reinvigorated. This is not merely desirable, but absolutely necessary. Without the Red Hat acquisition, IBM is threatened with advancing torpidity and imminent decline. For IBM right now, it is Red Hat do or die.
Red Hat’s Enterprise Linux operating system already contributes to the viability of IBM’s server offerings. But when an IBM hardware customer, let’s say a mainframe shop, installs RHEL it does so with other Linux alternatives on other platforms looming as contenders. Until now, those contenders could argue that IBM’s hardware is not the most prominent platform for RHEL, and therefore not the primary recipient of updates, security fixes and enhancements. That will no longer be the case. IBM will be able to assert its prominence in the Red Hat universe. A similar case can now be made for services arrangements that include the use of Red Hat products. When it comes to strategic initiatives, IBM will be able to combine its AI technologies including Watson related services, with Red Hat products and services. Basically, IBM’s position in competition with HP, Microsoft and Oracle will be enhanced, even if Red Hat continues to assert its independence and self-direction.
Ginni Romitty: IBM’s leader has the skills, talent and will to succeed with the acquisition of Red Hat.
Another important potential benefit of the Red Hat acquisition will be spiritual, notwithstanding the way the arrangement will also bolster IBM’s technical and financial strengths. Refreshing IBM’s corporate image from old hat to Red Hat can be enormously helpful. Making IBM more attractive to younger and more innovative executives on the client side, managerial as well as technical personnel, adds to Big Blue’s allure without in any way diminishing or denigrating the longstanding position the company holds with mature top management.
IBM’s managers have the skills, experience, motivation and vision to achieve all these goals. But that may not be enough. IBM will also need to be lucky. The success or failure of IBM’s dramatic decision to acquire Red Hat will depend in part on circumstances over which Big Blue has little or no control. IBM will need favorable exogenous conditions, particularly a suitable economic climate, to make headway. But those conditions may also favor its large, adept rivals. So IBM will also need good fortune to help it distinguish itself from its competitors and to bring the new appeal of its Red Hat acquisition and related strategic evolution to prominence.
In classical Greece, the importance and also the randomness of material fortune were embodied in the god Plutus, usually shown holding a cornucopia and often depicted as a child. Young Plutus is commonly depicted as carried by a goddess, most often Eirene but sometimes Tyche. Plutus is blind, and thus impartial. Plutus is not predictable and does not appear to have obvious motives or an agenda that can be shaped by a person or institution that would like his help. Nevertheless, recipients of the benefits Plutus can bestow are of course grateful. IBM, for example, would be very pleased if Plutus smiled on its efforts.
Tyche Carrying Plutus: The Greek god of fortune bestows his gifts with considerable randomness, so IBM and Rometty cannot be sure of his blessing.
Big Blue’s actions and hope will be particularly important as they affect three financial measures: IBM’s debt, net worth and goodwill on its books.
At the end of its 2018 third quarter, IBM reported total debt of more than $102 billion of which nearly $36 billion was long-term debt and a similar amount was short-term debt. If the Red Hat acquisition at about $34 billion was entirely added to IBM’s long-term debt, that figure would more or less double. Any ratios of this debt to the company’s revenue, profit, or assets would be dramatically affected. Basically, the acquisition is likely to leave IBM considerably in hock, although the company could issue or release common or preferred shares or engage in other actions to raise funds, offsetting some of the strains cause by the acquisition.
IBM’s net worth, reported shareholders’ equity, stood at nearly $20 billion according to the company’s third quarter financial reports. Red Hat’s net worth is a bit shy of $1.5 billion. The net worth of the combined companies would likely be more than IBM’s alone but not dramatically more.
Goodwill is the amount by which an acquisition by IBM exceeds the net worth of the acquired entity. Various acquisitions combined with the depreciation of goodwill over time left IBM with a net of $39 billion reported as goodwill plus other intangible assets. This figure is likely to soar to more than $70 billion with the acquisition of Red Hat.
All of these three figures will be acceptable to some investors and worrying to others. IBM has a very high credit rating and thus pays moderate interest on bonds and other borrowings. Adding to its debt might decrease its standing, but because the addition of Red Hat to its business has so many positive aspects, it is impossible for any commentator to guess how things will play out. Similarly, a small rise in net worth combined with increased liabilities could have an impact on the way IBM is perceived by the financial community. Lastly, ballooning goodwill is bound to raise questions about IBM’s ability to carry its increased financial burden, but again the way key figures in the financial community view the impact is bound to vary. IBM will undoubtedly fare better than most companies despite the greater strain on its resources.
Lakshmi: The powerful Hindu goddess of fortune has considerable influence over events in the material world, and IBM really needs any help she might provide right now.
Unfortunately, IBM’s timing against a background of substantial volatility in financial markets and uncertainty about American monetary and fiscal policies will make it harder for IBM to ride out criticism the way it might have several years ago. These are hard times for many companies. IBM’s most substantial rivals, very large enterprises with large and ambitious cloud services activities, companies like Amazon, Microsoft, Google and Oracle, are getting pummeled in the stock market. If this disquiet grows, IBM would be unlikely to escape its consequences. On the contrary, IBM might find itself at the center of concerns about the overall state and fate of web services companies. That concern will add to the challenges IBM must face as it tries to not merely integrate Red Hat but adapt the benefits of Red Hat’s innovative, open source corporate philosophy. IBM has made a very big bet, and this is bound to cause some affected and involved parties, not only investors but also big customers and employees to worry.
One very large part of IBM that will be affected by the changes is the services segment. This part of IBM includes a very large number of employees, many of them based in India. While it is very hard to say how IBM’s financial stresses might impact its standing in the race to amass the best South Asian workforce, the company’s services rivals, like Tata, Infosys and Cognizant, are bound to use any difficulties on IBM’s part to assert their strength and stability. The marketing challenge IBM already faces could become even more daunting. And once again hard numbers will not be the only determining factors, luck will also play a role.
In the East, notions of good fortune are embodied in the Hindu goddess Lakshmi, wife of Vishnu. Lakshmi is much more prominent in Eastern spiritualism than Plutus in the West. Whole portions of the Hindu religious spectrum are devoted to Lakshmi and her companions Parvati and Saraswati. And this turns out to be quite fitting for IBM right now. Good fortune in IBM’s worldwide services business, its intellectual power based in India, will be vital as Big Blue dons its Red Hat. If IBM can infuse its services business with the dynamic spirit that has made Red Hat so prominent and effective, the advantages of the Red Hat culture will be greatly enhanced, their inspirational power amplified.
While all this may make the Red Hat acquisition seem like a dangerous gamble on the part of IBM, actually the opposite might well the case. If IBM did not acquire Red Hat or find a comparable path to dramatic change and growth, a path that this observer does not believe exists, it is unlikely to grow and could, on the contrary, fade to the point where it might tip over and sink. The company’s legacy hardware business needs to remain relevant; the addition of Red Hat’s software and liveliness could do this. Its services business needs to unfold into a new generation of offerings with open source technology and other forward-looking ideas at its forefront. Its finances, even if they are put under additional strain, must be bolstered by hope in the financial, technical and enterprise communities.
With skill and luck, IBM’s acquisition of Red Hat can spark the kind of change that refreshes Big Blue for future generations of investors, customers and employees. Without this huge leap ahead, or a similar leap if there is one, IBM could end up in severe difficulty, not merely losing its hat but its head.
