IBM (NYSE: IBM) is behaving like a desperate company. For example, the granddaddy of America’s computer industry just spent $34 billion to buy Red Hat Inc. (NYSE: RHT).
The acquisition could be a desperate move because Red Hat is in a very different business than IBM. To clarify, IBM is a traditional computer company Red Hat sells open-source Linux-based solutions.
However, IBM is a major player in the software business. The company has been positioning out of hardware for a long time, Barron’s notes. For example, IBM sold its PC business to Lenovo in 2004 and its server business in 2014.
Will Red Hat help IBM (NYSE: IBM) conquer the Cloud
Red Hat will help IBM (NYSE: IBM) compete with cloud-based rivals like Microsoft (NASDAQ: MSFT) and Alphabet (NASDAQ: GOOG).
Notably, Microsoft just completed its $7.5 billion acquisition of massive open-sourced software registry GitHub. Ownership of GitHub gives Microsoft access to the work of 28 million software developers and 1.8 million organizations.
Owning Red Hat gives IBM access to a wide variety of Linux based solutions. Moreover, Red Hat’s Linux expertise is something Amazon Web Services (AWS) lacks. For example, AWS sales grew by 46% in 3rd Quarter 2018, Barron’s estimates.
The fear is that Amazon (NASDAQ: AMZN) could shut IBM out of the cloud with AWS. Cloud-based services for business clients are a big part of IBM’s business.
Red Hat will bring a lot of Value to IBM (NYSE: IBM)
Red Hat (NYSE: RHT) will bring a lot of value to International Business Machines.
For example, Red Hat possesses the world’s largest portfolio of open-source technology, Forbes contributor Panos Mourdoukoutas claims. Moreover, Red Hat operates an innovative hybrid cloud platform.
To add icing to the cake, Red Hat is well-respected in the open-sourced developer community. Thus, IBM gets access to a large pool of experienced open-sourced developers to extend its software reach.
For instance, IBM could utilize those developers in its work with blockchain projects like the Hyperledger. Beyond that Red Hat claims its Enterprise Linux delivers a 348% return on investment, 68% less downtime, and 26% faster development times. I doubt those claims, but they demonstrate the potential of Red Hat’s technology.
IBM (NYSE: IBM) Struggles with Shrinking Revenues
IBM (NYSE: IBM) is struggling with shrinking revenues. For example, IBM’s revenues shrank by 2.07% during 3rd Quarter 2018.
That figure marked the end of three quarters of revenue growth at IBM. In detail, IBM revenues grew by 3.7% in 2nd Quarter 2018, 5% in 1st Quarter 2018, and 3.55% in 4th Quarter 2017. However, those quarters marked the end of several quarters of shrinking revenues.
IBM is making money despite the shrinking revenues. For example, Big Blue reported a gross profit of $8.803 billion for 3rd Quarter 2018. In addition, IBM recorded operating income of $3.188 billion, and a net income of $2.694 billion on revenues of $18.756 billion, in 3rd Quarter 2018.
IBM (NYSE: IBM) is a Cash Rich Company
IBM is a cash rich company, it recorded a free cash flow of $3.289 billion and an operating cash flow of $4.332 billion on 30 September 2018.
Moreover, IBM (NYSE: IBM) recorded $11.731 billion in cash and equivalents and $2.932 billion in short-term investments on 30 September 2018. Thus IBM had $14.663 billion in the bank on 30 September 2018.
Hence, IBM has the cash to buy Red Hat. But is Red Hat itself making money? Will Red Hat add revenue to IBM or be a drag on Big Blue’s bottom line?
Is Red Hat Making Money?
Red Hat is not making that much money. For example, Red reported a net income of $86.85 million and an operating income of $134.56 million on 31 August 2018.
Conversely, Red Hat recorded a gross profit of $703.82 million on revenues of $822.75 million for 3rd Quarter 2018. That gave Red Hat an operating cash flow of $132.75 million, an investing cash flow of $87.38 million, and a free cash flow of $115.88 million on 31 August 2018.
Red Hat (NYSE: RHT) accumulated $1.748 billion in cash and short-term investments in 3rd Quarter 2018. In detail, Red Hat recorded $1.504 billion in cash and equivalents and $264.95 million in short-term investments on August 31, 2018.
Is Red Hat a Value Investment?
Judging by the financial numbers Red Hat is a profitable company. Moreover, Red Hat looks like a Warren Buffett style value investment.
To explain, Red Hat is an obscure and cash-rich company that specializes in infrastructure. In particular, enterprise Linux is a very unsexy but necessary kind of computer infrastructure.
Thus Red Hat is a value investment that will add value to IBM. Hopefully, IBM’s management will make invests like Red Hat.
However, Red Hat pays no dividend and its stock price was high at $171.91 a share on 5 November 2018. Thus, I classify Red Hat as one stock you can safely pay more for.
Is IBM (NYSE: IBM) a Value Investment?
IBM (NYSE: IBM); on the other hand, is a value investment right now. For example, IBM offers a high-dividend at a reasonable share price.
Notably, IBM offered shareholders a dividend yield of 5.43%, an annualized payout of $6.28, and a payout ratio of 45.4% on 4 November 2018. To add icing to the cake, IBM’s dividend has been growing for the last 18 years.
Best of all, IBM will to pay a $1.57 dividend on 10 December 2018. That dividend is up from $1.50 in February 2018 and $1.40 in February. Thus, IBM’s dividend grew by 17¢ in the last two years.
Therefore, IBM is a great dividend stock at the $119.82 share price reported on 5 November 2018.
If you are looking for a value investment in cloud computing and open sourced technology IBM is a logical choice. This stock offers a reasonable price, a great dividend, and tremendous growth potential because of Red Hat.