RBC analysis of IBM Red Hat deal suggests boost to earnings will pay for acquisition cost

IBM has been a laggard at the cloud party, but at least with its deal with Red Hat it has an opportunity to become the leading reveller in the hybrid cloud market, new analysis of IBM Red Hat deal finds.

The analysis comes courtesy of Amit Daryanani, from RBC, who suggests that IBM will see a lift in earnings per share that will justify the price it paid.

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He said that the boost to IBM will come from multiple opportunities:

  •  First off, Red Hat’s own revenue trajectory.
  • Via an opportunity to use Red Hat distribution to cross-sell IBM’s AI related technology and services, IBM middleware and analytics.
  •  To combine Red Hat’s services including OpenShift, which competes with Heroku from SalesForce, with IBM’s services.

Amit Daryanani said that Red Hat would benefit from “IBM’s scale, enterprise presence, and go-to-market in addition to the acquirer’s service capabilities.”

The bottom line

But what does this all mean in terms of dollars and cents?

The RBC analysis predicts that IBM’s earnings per share will rise from $13.80 a share to $15. Drilling down it forecasts as follows:

• $0.10-$0.20 earnings per share contribution from “core” IBM revenue growth;
• $1.00 from improved margins — before tax
• $0.10-$0.20 from share repurchases in 2019;
• $1.00 from gross Red Hat accretion;
• $0.20-$0.40 from sales synergies with Red Hat;
• $0.75-$1.25 in discrete tax benefits.

On the other hand, the interest on the cost of financing the deal is expected to cost $1 a share and IBM is also expected to suffer a $1.10-$1.20 per share impact from a higher tax-rate.

Breaking down the IBM/Red Hat deal in the context of the software M&A space

Where does the IBM/Red Hat deal fit in the context of global and US software M&A — according to Mergermarket data

In all, Amit Daryanani’s analysis of IBM Red Hat finds that the deal is nine times Red Hat’s expected revenue over the next 12 months, “which is inline with the multiples paid in recent software transactions,” but that IBM is only paying 33 times Red Hat’s predicted EBITDA (earnings before interest, tax, depreciation and amortisation) compared to an industry median for software related mergers and acquisitions of 88.

Finally the ratio of enterprise value to free cash flow — EV/FCF — is 33, compared to an average of 56 for recent deals in this space.

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Michael Baxter

.Michael Baxter is a tech, economic and investment journalist. He has written four books, including iDisrupted and Living in the age of the jerk. He is the editor of Techopian.com and the host of the ESG...

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