IBM hopes to stay relevant with Red Hat deal

Ginni Rometty, IBM’s embattled chief executive, is finally ready to roll the dice.

The IBM chief has struggled with playing defence, as Big Blue has grappled with falling sales of its traditional technology while trying to tap new areas of growth such as artificial intelligence and security. It has not worked: IBM’s revenues turned down again in the latest quarter, ending a brief moment of respite after nearly six years of contraction.

But Ms Rometty is now ready to shake off the caution that has characterised her nearly seven years at the helm. Monday’s news that IBM had agreed to pay $34bn in cash for leading open source software company Red Hat represents its largest deal by far, and an attempt to reposition the company as a leader in the future of IT, not just the past.

“This is all about growth,” Ms Rometty said as she announced a deal that makes IBM a contender in the cloud computing market dominated by Amazon Web Services and Google. “We’re playing to be number one.”

The bravado resonated with investment analysts, many of who had lost confidence in her efforts to reverse the slide. The immediate response on Wall Street: it will be hard to pull off, but IBM finally has a strategic answer to the issues that were accelerating its drift into irrelevance.

Toni Sacconaghi of Sanford C Bernstein summed up the reaction among investors, saying: “Congratulations on your conviction.”

‘The easy part’s done’

If Ms Rometty succeeds in rebooting IBM, it will rank as one of the greatest technology industry turnrounds, alongside the rescue of Big Blue engineered a quarter of a century ago by Lou Gerstner.

Back then, many of the big companies and governments that were IBM’s traditional customers were turning away from its mainframe systems, but were struggling with the complexity of a new client/server computing architecture championed by companies such as Microsoft. Mr Gerstner made systems integration the key to IBM’s turnround, turning IT services into the foundation for the new IBM.

Today, with the architectural shift to cloud computing, Ms Rometty believes she has a similar opportunity. The transition to the cloud began with companies moving individual computing workloads to the centralised systems run by Amazon — and, later, Microsoft and Google. Now, they are facing the challenge of integrating these with their existing data centres, which represent massive sunk costs.

“The easy part’s done,” Ms Rometty said of the first stage of the new cloud market. But she added that the biggest users of computing are once again struggling: “They need help.”

IBM’s bet is that companies will link their existing computing resources to the cloud in a new “hybrid” infrastructure. Microsoft’s latest earnings bear witness to the financial opportunities in this strategy: its cloud platform, Azure, is growing at more than 70 per cent, but it also has strong sales of traditional server software, as the two sides of the business grow in parallel.

A second force that Ms Rometty is hoping to tap is the persistent worry among big customers that they will become overly dependent on any single tech company, in a technological dependency known as “lock-in”.

“This cloud battle is going to be open versus proprietary,” she said, with IBM the champion of an open source technology platform that provides the only real alternative to one of the emerging “super-clouds”.

Like turning round two supertankers

The argument resonated with Wall Street. Despite paying a massive premium, IBM lost only about 2 per cent of its value on Monday, while Red Hat’s market value jumped by roughly $10bn.

But making the deal work will be challenging. IBM has a history of dealmaking, shuffling and re-shuffling its portfolio of technologies to keep pace with the changing technology times. Its biggest deal until now was the $5bn purchase of business intelligence company Cognos more than a decade ago. With Red Hat, it is going for something completely different: re-engineering its core technology strategy in an effort to present a new, and more relevant, face to its customers.

Phil Dawson, an analyst at IT research firm Gartner, likened the task to turning round two supertankers. If IBM has been backward-looking in trying to defend its old technology base, Red Hat is also trying to reposition itself for the cloud, he said.

Red Hat rose as the dominant Linux company, providing the support and services companies needed as they moved to the open source operating system. But with Linux well established, that transition is now complete, Mr Dawson said — as evidenced by the company’s slowing growth and declining share price in the last year.

Together, IBM and Red Hat must show they can extend their combined technology base to link it more closely with the cloud. Red Hat has gained recognition for a newer set of technologies on which the “hybrid cloud” sales pitch will depend, though the revenue is still minimal.

One is OpenShift, a technology framework that involves breaking down monolithic corporate software programs into smaller, inter-connected segments. Known as containers, they can be easily moved between different computing platforms, greatly increasing the efficiency of both developing and deploying complex applications. They also hold out the promise of spanning both internal data centres and public clouds.

As the largest distributor of Linux, Red Hat has become a key partner for many other old-line IT companies, among them Hewlett Packard Enterprise, Dell and Cisco. Its newer technologies also rely on industry partnerships: Microsoft’s Azure cloud service, for instance, now supports Red Hat’s OpenShift.

“Will Oracle and Microsoft continue their relationships with Red Hat if IBM is behind them? Maybe not,” said Mr Dawson.

He added that rivalry between the big tech companies could even lead to a “fragmentation” of the Linux platform if IBM’s rivals feel compelled to support their own versions of the software and drop Red Hat — in an outcome that would represent a huge backwards step for the industry.

Ms Rometty is aware of the danger. Referring to Red Hat’s historic independence from the traditional IT giants on Monday, she insisted: “We’re absolutely going to preserve this Switzerland.”

After a long retreat, Ms Rometty has finally shown she is ready to tear up the playbook she inherited and face up to the extent of IBM’s strategic crisis.

Open-source technologies underpin major deals

2018 has been a big year for Linus Torvalds. As the original author of both the Linux operating system and Git, a code management tool, Mr Torvalds’ open-source technologies stand behind two of the tech industry’s biggest deals this year: Microsoft’s $7.5bn acquisition of Github and now IBM’s $34bn purchase of Red Hat.

But the nature of open source software — which is developed based on the voluntary contributions of millions of developers and licensed for free — means that Mr Torvalds will not see the sort of huge rewards that other tech founders might expect.

The involvement of big corporations, from IBM to Google, in the collaborative and sometimes idealistic open source community is nothing new. Even Microsoft, which just a decade ago was wielding its intellectual property against Linux, recently licensed tens of thousands of its patents to the Open Invention Network, a defensive patent pool designed to inoculate open-source developers against such litigation. IBM was a co-founder of the OIN in 2005, alongside Red Hat and others.

“We are a longstanding champion of Linux and the open source community,” Ginni Rometty, IBM’s chief executive, said on Monday.

Nonetheless, some open source developers were shocked that IBM had swooped on what many saw as the company that had best balanced the commercial and community interests of Linux.

“I’m having trouble picking my jaw up off the floor,” Dan Sneddon, a Red Hat engineer, said on Twitter.

Some developers have accused IBM’s involvement in open source projects as being overly self-interested.

“Developers have a more positive view of Red Hat than they do of IBM,” said Patrick Moorhead, analyst at Moor Insights & Strategy. “There will be a bit of consternation, like there always is on a big acquisition like this.”

But Jim Zemlin, executive director of the Linux Foundation, a non-profit that supports open source development and adoption, said IBM “deserves some credit” for its long involvement in the sector, including helping to defend Linux from patent litigation in the 2000s.

Its $1bn investment in Linux in 2000 was “a seminal moment in the history of Linux”, he said. “In the very early stages of commercialisation, a huge commercial technology vendor endorsed an open source strategy.”

Most of Silicon Valley’s most successful companies have built on top of open source software, Mr Zemlin added.

“Their value capture is on top of a bunch of open source software that enables them to get to market better, faster, cheaper — reducing cost by collectively developing infrastructure, even with their competitors. That’s just a fundamental shift that happened some time ago in the tech industry.”

Tim Bradshaw in San Francisco

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