IBM Bought a Hat Company?


IBM paid $33bn for a hat company? This week we dive into why IBM bought Red Hat and try to understand the future of cloud computing

Hat Sales

For a company that has “Hat” in its name, it’s surprising Red Hat does not disclose their own hat sales. After diving into 10-Ks, 10-Qs and analyst reports, no one mentions hat sales; even if they did, the results do not look promising. The Boring Company, Elon Musk’s tunneling company, recently had a hat sale which raised about $1mn; but the issue with Red Hat is their flagship “red hat” has a starting price of $8 (a steal and great stocking stuffer), 60% lower than the Boring Company.

Luckily, Red Hat isn’t a hat company

Originally founded in 1999, Red Hat was one of the first companies to make a profit selling open source software and Red Hat describes themselves as a “leading provider of enterprise open source solutions.” Red Hat recognized that companies were willing to use open source software, but needed enterprise level support, testing and security, and were able to develop a product that delivered all of these needs. Red Hat’s model is a win-win; companies have the flexibility of working with open source software, but also get the enterprise support they need.

Red Hat makes about 70% of its $3bn in revenue from selling an enterprise version of Linux, aptly called Red Hat Enterprise Linux (RHEL). When companies buy servers, they need to install operating systems on these servers, and more and more these companies are choosing RHEL. While Red Hat has made great business decisions, they have also benefited from a shift to Linux based servers, with the Linux share of servers growing 300% since 2011.

But, this isn’t why IBM is buying Red Hat

IBM put out a very cloudy press release about their acquisition and I will use some quotes from their release to show you what I mean:

“The acquisition of Red Hat is a game-changer. It changes everything about the cloud market,”

“IBM will become the world’s #1 hybrid cloud provider, offering companies the only open cloud solution that will unlock the full value of the cloud for their businesses.

Most significant tech acquisition of 2018 will unlock true value of cloud for business

IBM and Red Hat to provide open approach to cloud

As you could have probably guessed, Red Hat also sells software for the cloud. About 20% of Red Hat’s revenue comes from products that help customers manage cloud services, and while it is only a small portion of their revenue, the thinking is as more companies shift their resources to the cloud, they will need more software to support their cloud endeavor.

However, it’s easy to just gloss over all of the details about how Red Hat’s cloud portfolio works or whether or not Red Hat is actually a cloud company, like so many of the talking heads do; instead we are going to dive into their portfolio and get an idea of where Red Hat is going, not what they are today.

We’ll start with the easier part

Red Hat makes money by selling a “cloud” version of RHEL. When you decide to deploy cloud resources, these resources need to run on an operating system and if you choose to use RHEL, you will have to pay for it. Cloud RHEL revenues are about $200mn and only represent about 10% of RHELs total revenue, but it is worth nothing that Jim Whitehurst, CEO of Red Hat, said about a year ago “in aggregate, customers utilizing our cloud-enabling technologies either on-premise or in the public cloud are spending more with Red Hat than customers that have not yet embraced our cloud-enabling technologies”.

Now, the complicated part

The most intriguing part of the Red Hat’s portfolio is its OpenShift product. OpenShift, is a cloud/on-premise solution for managing containers. And containers are going to be big.

What is a container?

Containers are packages of software that contain all the code, dependencies, system libraries, etc, that are required to run the software (or app). The beauty of containers is they can run consistently, across different infrastructure configurations, because they have all of these dependencies packaged in. If you need to scale up, scale the hardware up and the container runs fine, and if you need to scale down, well that works too. Considering the scale up/down argument is why people choose the cloud, its only natural to put containers on the cloud.

To really get an idea of what containers are, I am just going to use an analogy Barclays uses about containers:

The best way to understand containers is to think of an apartment in an apartment building. The apartments come in various shapes and sizes, whether it be studios or 3-bedroom apartments. Each apartment also provides necessities such as a refrigerator and dishwasher. The apartment building provides shared services such as laundry, plumbing, a front desk etc. to all the apartments. Such a shared rental infrastructure allows tenants to get and pay for exactly what they need, while providing economies of scale to the apartment building landlord.

The container market could be enormous

According to 451 research, container software revenue is expected to quadruple to $3.4bn in 2021 and Barclays believes the ultimate container opportunity for Red Hat could be between $10 -$13bn. While container adoption is still early, apparently, Google relies on containers so much, The Register wrote an article saying everything that runs in Google is a container. Google is also helping companies use containers and in a recent Google Blog post, Google describes how it teamed up with the NY Times to apply machine learning to its photographs, and articulated how easy it was to do this, using containers.

The ultimate IBM vision

The ultimate win for IBM would be if consumers still install RHEL on their on-premise systems, use RHEL in the cloud, use Open-Stack to manage their containers, then throw in Red Hat IoT and serverless management software, and viola, you have a $33bn bargain.

For all of the AI lovers out there, sorry for not mentioning it once this week, this is Cloudy with a Chance of AI, after all.

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