Wedbush: IBM-Red Hat Deal Holds Execution Risks

IBM IBM closed on its acquisition of Red Hat Inc RHT Tuesday. 

While the deal marks IBM’s acquisition of “critical mass” in the hybrid cloud market, the deal poses potential execution and other risks, according to Wedbush.

The Analyst

Moshe Katri maintained a Neutral rating on IBM with an unchanged $165 price target.

The Thesis

With the acquisition of Red Hat, IBM looks to become the world's leading hybrid cloud provider, according to Wedbush. 

Most companies are in the early stages of cloud adoption, where the intention is to increase compute power for cost-cutting. The combination of IBM and Red Hat could enable companies to shift business applications to hybrid cloud to maximize benefits of the cloud for their businesses and driving growth, Katri said in a Wednesday note. (See his track record here.) 

Yet the deal values Red Hat at $34 billion, which represents a substantial premium to the current multiples of cloud peers, the analyst said. 

IBM expects the deal to boost revenue growth, gross margin and free cash flow within 12 months of closing. On the other hand, the company plans to suspend share repurchases in 2020 and 2021, Katri said. 

Red Hat has a volatile billing history and the deal poses execution challenges, he said.

“In order to unlock shareholder value, we advocated a different approach, which would have included an aggressive restructuring of IBM’s underperforming business, with a focus on improving profitability, returns and FCFs.”

Price Action

IBM shares were up 1.17% at $140.93 at the time of publication Wednesday.

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