Thursday, December 13, 2018Canada's Leading Online Business Magazine

What the Red Hat Acquisition Says About the Open Source Ecosystem

By Bart Copeland

I’ve been working in open source for more than 12 years and never could have predicted the $34 billion acquisition of Red Hat by IBM. Frankly, it makes me concerned for the open source ecosystem.

It was a watershed moment for open source when Red Hat was founded in 1993. Founders Bob Young and Marc Ewing helped fuel not only what has become the norm for development and open source but also the widespread adoption of open source by companies. Not surprisingly, Red Hat became synonymous with both the Linux operating system (OS) and open source for enterprise.

Open to the Core

Red Hat is a key player in the open source ecosystem, with its roots in open source. The company has done a phenomenal job with Red Hat Linux (RHEL) and has achieved success around a host of other open source projects spanning middleware, cloud, virtualization, containers and applications. Red Hat has also embraced Kubernetes and shown its ability to be nimble in its open source solutions within the changing cloud and microservices models.

Closed But Supporting Open

In contrast, at its heart, IBM is an international enterprise that started out as closed source or with roots in closed source. IBM has evolved to be a large proponent of open source and has backed numerous open source projects over the years and is instrumental today in many key open source projects. However, IBM has become less of a tech leader in the last decade and has been struggling in the last few years; we’re now witnessing the FANG (Facebook, Amazon, Netflix, Google) generation.

On the other hand, Microsoft has done a good job at staying relevant, pushing hard on its Azure cloud play and being developer- and open source-friendly, as is most recently evidenced by the GitHub acquisition. In fact, Microsoft is now worth more than each Google and Amazon (based on current stock prices). It looks like IBM is trying to follow in Microsoft’s footsteps and stay relevant given its downward trend over the last six years.

Impact on Open Source

The acquisition is worrisome because it may impede Red Hat’s continued innovation momentum and because it’s a hit to the open source ecosystem. There is something to be said for different companies in the open source ecosystem versus the oligopoly we’re starting to see emerge. It’s been communicated that Red Hat will be an independent business unit. Red Hat CEO and President Jim Whitehurst will be reporting directly to IBM’s CEO, Ginni Rometty. That said, I find it hard to believe that there won’t be a strong IBM influence that will impact Red Hat’s continued innovation adversely.

Puzzling Financials

In addition, the financial aspects of the acquisition are puzzling. The acquisition price was made on a 10 to 11x factor of Red Hat’s trailing twelve months revenue. This is a good but not great multiplier for such a strategic acquisition. Red Hat was bought at approximately a $14 per share premium over its highest share price reached in June of this year, approximately $176.

However, we’re in a down market, the tech stock market has been off and, prior to the announcement in late October, Red Hat closed at $117 per share. I find it odd that the Red Hat board would sell at this price, given it’s a bear vs. bull market. What does Red Hat’s board know that we don’t know about selling in a down stock market?

Finally, IBM’s revenue is $75-80 billion per year whereas Red Hat’s is about $3 billion per year. Red Hat’s revenue is not going to make a material difference to IBM’s top line in the short term, nor are Red Hat’s earnings going to make a material difference to IBM’s bottom line. Therefore, as Ginni has reported, there are some very strong strategic synergies by integrating Red Hat into IBM to reverse the downward trend of its revenue and justify the $34 billion price tag. I am skeptical at this point that these synergies will be realized. Time will tell.

What’s Next?

Though this acquisition has created many uncertainties, what remains true is that open source is here to stay, and we’ve now seen a key open source leader will be consolidated under IBM. There is still lots of opportunity for other open source players to be quicker and drive greater innovation. I don’t believe the innovation we need within the open source landscape will occur at IBM or even at Cisco, Amazon, Google and Microsoft. This means it will allow smaller organizations to leverage the open source ecosystem and drive game-changing innovation to benefit users and customers.

This deal has likely created a hole in open source leadership. Who will fill it? It will be interesting to watch who rises to the challenge.

Bart Copeland is the CEO and president of ActiveState, which is reinventing build engineering with an enterprise platform that lets developers build, certify and resolve any open source language for any platform and any environment.