IBM-Red Hat Case Study - Sesson 7 PDF

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IBM Makes the Third Largest Tech Acquisition in History This case tells the story of the acquisition of Red Hat by IBM announced in late October 2018.

IBM IBM (International Business Machines Corporation) was founded in 1911 and is known in the technology industry as Big Blue, a reference to its once ubiquitous blue computers. IBM revolutionized the global computer industry when it launched its first desktop in 1981. For most of the 1990s, IBM had a strong PC business and the ThinkPad was the anchor of its portable personal computer [i.e., laptop] line. By the late 1990s, however, the company's PC division had run up huge losses, leading it to pull back from the retail market and focus instead on corporate and government clients. As a result, its share of the global PC market fell to around 6%. Soon, IBM became interested in getting out of the PC hardware business and, in 2004, sold its PC business to Chinese group Lenovo in a $1.75bn deal. IBM retained only its supercomputer hardware business. This transaction was consistent with IBM's strategy to focus on the higher-margin segments of enterprise computing services (e.g., consulting and software). In 2011, hardware accounted for only 7% of IBM’s pre- tax income, while the software business already accounted for 42% of its result. However, in 2012, as the sector evolved, IBM once again started to experience difficulties, leading to several waves of layoffs. Since 2013, IBM has been seeing its second major transformation, this time toward cloud-based services such as infrastructure, platforms and software (please see below). Today, IBM offers a variety of cloud-based solutions (e.g., site hosting for major companies, healthcare applications for insurers and hospitals, and computing power for internet-based applications). In the last decade, the company also invested in Machine Learning with their famous Watson platform, which can be used to analyse massive amounts of data in a short time. IBM’s revenue growth slowed down over the last five years. Although the company is among the industry leaders, an employer of hundreds of thousands of people worldwide, and worth hundreds of billions, they are seeing tough competition. Microsoft, Amazon and Google all offer cloud-based solutions comparable to IBM’s, as do many smaller niche start-ups. Interest in IBM’s products and services decreased in recent years as competitors eroded their market share.

Cloud Computing Cloud computing refers to delivering on-demand computing services (originally storage, and more recently processing power and apps), that run on the internet instead of your computer. Clients use these services on a pay-as-you-go basis. Dropbox, Netflix, Flickr, Google Drive, Microsoft Office 365, Yahoo Mail are all cloud services. The 'cloud' in cloud computing has its origins in network diagrams that draw the internet as a fluffy cloud.

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Cloud computing simplifies things for companies. The burden of owning datacenters (i.e., servers) and company infrastructure is gone. Instead, companies can then rent the applications, processing power, and storage they need from their cloud service provider. Costs are reduced and the companies only pay for what they actually need and use, with the ability to expand as needed, on demand. Also, the maintenance and updates are all done by the cloud service provider, reducing the tasks for in-house IT. The first half of cloud computing is the cloud. While the cloud is not local to the computer, there is some variation to where it is located. For example, there is the term public cloud where the company is not responsible for the upkeep of the server. Its counterpoint is private (i.e., company-owned) cloud, where the company takes on the maintenance. The private cloud can be physically at the location, known as on-premises cloud, or located more remotely at a datacenter. The private cloud is often used for more sensitive applications that require maintaining control of the data for higher-level security. A popular solution today combines aspects of a private cloud with a public cloud, gaining advantages of distributing the workloads for optimal performance. This is known as a hybrid cloud solution. Increasingly, the hybrid cloud is evolving to the multi-cloud. “Multi-cloud” refers to the use of multiple public cloud infrastructures. An enterprise might start with a couple of applications running on Amazon Web Services (AWS) and then start to add workloads to Microsoft Azure or Google Cloud Platform. Multicloud allows enterprises to use several cloud service providers. If one public cloud vendor suffers a localized failure, the enterprise could switch workloads to a different vendor’s infrastructure. Multi-cloud strategies also enable enterprises to (i) match particular workloads, applications, and geographic locations to specific public cloud vendors’ strengths; (ii) reduce costs by taking advantage of special deals and competitive pricing among public cloud vendors; and (iii) avoid vendor lock-in. However, connectivity is a paramount

consideration in enterprises’ ongoing journey from on-premises datacenters to hybrid cloud to multicloud operations. Each public cloud vendor has its own ways of working and they are not enthusiastic about making it easy to connect with their competitors’ cloud infrastructures. The other half of cloud computing is the computing part and these days just about any application is amenable to cloud computing. Cloud-based services can be placed into three categories. A popular one is SaaS, which stands for Software-as-a-Service. Other variants of cloud computing applications include PaaS (Platform-as-a-Service), and IaaS (Infrastructure-as-a-Service). Please see below the top cloudservice vendors.

Source: Apps Run the World, March 2018

Software-as-a-Service SaaS is a software distribution model in which a service provider hosts applications for customers and makes them available to these customers via the internet. SaaS offerings involve a variety of business applications including email, customer relationship management (CRM), billing/payroll processing, database management, enterprise resource planning (ERP), content and document editing. A popular example of SaaS is the Microsoft Office 365 suite. Rather than selling the program as a product, Office 365 is sold as a subscription. For the price of $9.99/month, all the Microsoft Office applications are included. Advantages include that the software, as it is hosted on their server, is continuously kept up to date, and documents are backed up to the cloud for reliable storage, and ease of sharing. Other popular examples of SaaS include Adobe Creative Cloud and Salesforce’s CRM software.

Platform-as-a-Service Platform-as-a-service (PaaS) is a type of cloud computing offering in which a service provider delivers a platform to clients, enabling them to develop, run, and manage applications without the need to build and maintain the infrastructure required by such software development processes. The customer controls software deployment while the cloud provider delivers all the major IT components needed to develop applications, including storage systems, networks, operating systems, and databases. PaaS can be regarded as an assisted do-it-yourself alternative to software development, where customers develop their own customized IT solution using the tools and building blocks offered by the PaaS provider. A popular example of a PaaS is Microsoft Azure App Services, which is used by top organizations including Toyota, UPS and Coca-Cola. In fact, Microsoft claims that 90% of Fortune 500 companies use it. The hosting is done across 54 different Azure datacenters available in 140 countries. Another example of PaaS is the Google App engine, which allows programmers to develop apps on Google’s platform. Infrastructure-as-a-Service In the IaaS model, third-party service providers host hardware equipment, operating systems, servers and various other IT components for customers in a highly automated delivery model. IaaS services offered to clients are delivered via the internet and pulled from multiple servers and networks that are generally distributed across numerous datacenters owned and maintained by the cloud provider. IaaS also provides essential services such as security, log access, and monitoring services to provide a more robust offering with a turnkey solution. There are many examples of IaaS, with popular ones including Amazon Web Services, Microsoft Azure and IBM Cloud. Main competitors The December 2016 acquisition of LinkedIn by Microsoft catapulted the Windows developer to the No. 1 spot in the overall cloud-service space, edging past Amazon (the IaaS leader) and Salesforce (leader in SaaS and PaaS categories). Microsoft currently leads Cloud Computing because of the breadth of its offerings in all three types of services (e.g., Azure for IaaS; Azure App for Paas; LinkedIn and Office 365 for Saas). [NB. Amazon does not do Saas, while Salesforce does not do IaaS.] The main challenge for Microsoft is to reconcile its cloud endeavors with its Windows historical model. This proprietary software model is sometimes perceived by customers as an inhibiting factor (i.e., customers fear being trapped in a specific cloud system to a software publisher). Microsoft is trying to get out of this trap by thoroughly playing the card of open source (a third of Microsoft’s cloud already works with Linux). In 2017, Amazon posted a 41% jump in Amazon Web Services revenues after a 38% increase in 2016 and currently has the largest IaaS footprint in the world. Amazon also invested heavily in Artificial Intelligence, Machine Learning and Alexa-powered services for businesses, which features voice assistance for managing work calendar. Salesforce was one of the SaaS pioneers and currently is the leader in both PaaS and SaaS. Salesforce plans to retain its position, especially after the 2018 acquisition of MuleSoft, a company specializing in cloud integration offerings.

Table below shows top 5 vendors by cloud service category and their key offerings for PaaS, IaaS and SaaS. Rank

1

2

Top Cloud Computing Vendors

Microsof

Amazon

4

5

Salesforce

IBM

Oracle

2016-2017 Growth, %

Key Cloud Offerings

PaaS

200

400

100%

Azure App Service, Logic Apps, Functions, Azure SQL Database, SQL Data Warehouse, Visual Studio Team Services

IaaS

6702

11001

64%

Microsoft Azure

SaaS

3415

6969

104%

Total

10317

18370

78%

PaaS

990

1700

72%

IaaS

9900

13663

38%

SaaS

0

0

0%

10890

15363

41%

1442

1929

Total 3

2017 Cloud Revenues, $Millions

2016 Cloud Revenues, $Millions

Cloud Category

PaaS

34%

IaaS

0

0

0%

SaaS

6315

7781

23%

25%

Total

7756

9710

PaaS

200

225

IaaS

5937

7124

SaaS

698

750

13% 20% 7%

Total

6835

8099

18%

PaaS

1247

1608

29%

IaaS

0

SaaS

2823

Total

4070

Source: Apps Run the World, March 2018

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LinkedIn, Microsoft Office 365, Dynamics CRM, Dynamics 365

Amazon Aurora, Dynamo DB Amazon Web Services

Salesforce Platform

Salesforce Sales Cloud, Service Cloud, Marketing Cloud, Commerce Cloud

IBM Watson IBM Bluemix, IBM Cloud IBM Kenexa

Oracle Cloud Database 12c

0% 4305

5913

52% 45%

Oracle Cloud ERP, NetSuite

IBM posted relatively solid results with an assortment of cloud offerings in 2017. It currently offers over 170 services delivered through its cloud infrastructure consisting of 60 datacenters in 19 countries. IBM’s offerings include IaaS, PaaS and a fair amount of security and healthcare-oriented SaaS. Finally, continued expansion of Oracle Database at enterprise level is expected to be a major development that could shape the Platform as a Service (PaaS) category. It is safe to assume that the steep costs of delivering cloud infrastructure will limit the number of viable IaaS players, while the PaaS and SaaS categories are in flux and incumbents and new comers will continue to trade places.

Linux and Red Hat The Linux operating system is an “open-source” software. This means that the binary form of the software is distributed along with its source code (i.e., the high-level programing instructions that tell the computer what functions to perform). Since users have access to the source code, they can make changes to the program according to their needs. In 1991, a Finnish undergraduate student, named Linus Torvalds, started developing a freely available Unix-like1 operating system. He posted his early code on an Internet software newsgroup and soon a community of tens of thousands of users started contributing by writing “patches” to bugs and developing new features for the open-source software now named Linux. Currently, the development and standardization of Linux is managed by the Linux Foundation, which is funded by companies such as AT&T, Cisco, Fujitsu, Hitachi, Huawei, IBM, Intel, Microsoft, NEC, Oracle, Qualcomm, and Samsung. While the latest versions of Linux and Linux-related software can be downloaded free on the Internet, integrating all the components is a highly complicated and time-consuming task. Many people and organizations prefer to pay for an integrated ready-to-install version of Linux. Over time, many distributors (e.g., Red Hat and Caldera) began selling braded versions of Linux, which were enhanced and customized by their own developers. Red Hat also provided an installation manual and technical support. Even with the additional service layer, the prices of branded Linux versions remained significantly more affordable than proprietary operating systems such as Windows. Initially, the Red Hat Linux was sold on CDs. However, the company later transitioned to a subscription-based business model. Bob Young, former Red Hat CEO, explained the business model: “I think of it an awful lot like the car industry. You could buy your tires from Michelin, your airbags form TRW [i.e., a specialized supplier], and so on. But very few of us actually build our own cars. We tend to go to a dealer and buy a Ford or a BMW. Of course, the engineers at Red Hat will tell you that we build a BMW.” Red Hat’s versions of Linux include thousands of software packages, of which Red Hat engineers develop only a small fraction. However, the packages developed by Red Hat include key programs such as the installer and a Package Manager. The Red Hat Package Manager (RPM) ensures the effective and timely updating of the operating system.

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Unix is a family of operating systems created in the 1970’s by AT&T’s Bell Labs.

In 1999, Dell announced that it would factory-install the Red Hat Linux operating system on Dell Servers and Workstations. Soon thereafter, IBM started collaborating with Red Hat to optimize IBM hardware for running Red Hat Linux. Around the same time, Goddard Space Flight Center developed the first Linux supercomputer. Today, Linux utterly dominates supercomputing. In 2003, Red Hat developed Red Hat Enterprise Linux (RHEL). Today, RHEL subscriptions is Red Hat's leading income source. Despite the fears of both internal and external critics, Red Hat remained close to the Linux developer community. The company COO explains: “The last thing we want to do is start getting isolated from the community, which we are sometimes accused of. However, we are the ones that give everything back to the community. Every piece of code we write goes back to the community. And remember we have three or four top Linux developers on our payroll, and they are developing just Linux, not Red Hat stuff– that’s just another sign that we’re trying to make sure the community and Linux development remains solid.” By 2016, Red Hat became the first $2 billion Linux company. However, in the same year, Red Hat was shifting its long-term focus from Linux to the cloud. This was a natural transition, since Linux is the backbone of all the largest cloud infrastructures (e.g., Amazon Web Services, Microsoft’s Azure, Google Cloud, etc). "Every time you use Google, you're using a machine running the Linux kernel," as Google's Chris DiBona has said. Some argue that Linux could be the basis for ensuring multi-cloud connectivity. Red Hat is working with rivals and partners (e.g., Micorsoft) in open-source projects such as OpenStack, Red Hat’s IaaS offering. Instead of betting only on the crowded IaaS market, Red Hat moved into the far more open PaaS market with its OpenShift platform. However, while Red Hat has its own cloud platforms, RHEL and related programs also run on other clouds such as Amazon Web Services and Microsoft Azure.

IBM buys Red Hat In October 2018, IBM announced it had agreed to acquire U.S. software company Red Hat for $34 billion, including debt, as it seeks to diversify its mainframe hardware and consulting business into highermargin subscription-based software offerings. The transaction is by far IBM’s biggest acquisition. IBM, which has a market capitalization of $114 billion, will pay $190 per share in cash for Red Hat, a 63 percent premium to [pre-acquisition] share price. Red Hat will be offering IBM important subscription revenues and growth potential in cloud services. Estimates say the cloud market will be worth $240 billion by next year, while 83% of enterprise workloads will move to the cloud by 2020. With this deal, IBM is hoping to target enterprise customers who are still in the early stages of their cloud migration journey. While many companies have already invested in public cloud services, there are still many existing applications that will need to be modernized before they can run effectively in the public cloud. “This acquisition is clearly seeking growth synergies. This is not about cost synergies at all,” IBM CEO Ginni Rometty said in an interview. The CEO further said IBM “paid a very fair price. This is a premium company. If you look underneath, this is strong revenue growth, strong profit and strong free cash flow.”

IBM shares have lost almost a third of their value in the past five years. Before 2018, it had 22 straight quarters of revenue decline and it has lost over $28 billion in revenue over the past six years. Meanwhile, Red Hat shares are up 170 percent over the past 5 years.

Cloud, Linux and security are the big drivers on IBM’s part. “IBM is [focusing] on the cloud, but they also are going for a grab in Linux for their largest and most important open source community and some of the newer tech on security [develped] by Red Hat,” TechCrunch reported. Since much of the cloud is Linux- based, IBM can hope to develop new software deliverable in the SaaS model that is compatible across public clouds, thereby unlocking the multi-cloud connectivity barrier. IBM also has an opportunity to leverage its marketing and global reach to encourage mainframe and legacy clients to adopt OpenShift [i.e., Red Hat’s offering in PaaS]. Moreover, IBM is hoping the deal will help it catch up with Microsoft, Amazon, and Salesforce in the rapidly growing cloud business. IBM will immediately be adding Red Hat’s OpenStack a...