IBM’s bets on AI and hybrid cloud pay off

After underperforming the market for most of the past decade, IBM is seeing its strategy of acquiring companies to build a broad, multicloud platform start to pay real dividends.

On March 12, IBM stock hit an all-time-high share price of $197.78, putting an exclamation point on a remarkable turnaround for the company whose shares nosedived to a low of $74 in 2020. In the fourth quarter of last year, IBM revenue grew by 4%, year over year, reaching $17.4 billion. Annual revenue hit $61.8 billion, a 2% increase over 2022.

Arvind Krishna, IBM chairman and CEO, credited AI and hybrid cloud as the key drivers of the company’s resurgence. “In the fourth quarter, we grew revenue in all of our segments, driven by continued adoption of our hybrid cloud and AI offerings.”

“Every client I speak with is asking about how to boost productivity with AI and how to manage their technology stack, much of which is deployed across a hybrid environment, public, private, and on-premises. These trends continue to fuel demand for both hybrid cloud and artificial intelligence,” he said in IBM’s fourth quarter earnings call.

Big Blue’s cloud shopping spree

Not long ago, IBM was an afterthought in the cloud market, lagging behind AWS, Microsoft Azure, and Google. However, after a decade of cloud-related acquisitions, the company is building out two platforms, a multicloud platform and an AI one, that offer several advantages over the Big 3 hyperscalers. These include cross-platform automation, the ability to integrate with multiple clouds, and professional services tie-ins through IBM’s consulting arm.

IBM’s big bets on cloud started in 2013 with its $2 billion acquisition of SoftLayer, whose public cloud platform served as the foundation for what eventually became IBM Cloud, and continue to this day.

This past year alone, IBM acquired several cloud-related companies, including Polar Security (cloud data protection), NS1 (network and cloud automation), and Apptio (hybrid cloud cost control software).

IBM’s most important cloud acquisition to date is its $34 billion purchase of Red Hat, the largest acquisition in IBM’s history. The Red Hat deal was architected by Krishna, a long-time IBM veteran who was then serving as head of the IBM Cloud and Cognitive Software business unit.

In 2020, Krishna ascended to CEO, and that’s when IBM stock began its dramatic ascent. Since Krishna took the helm, IBM has acquired 30 companies that are being integrated into IBM’s hybrid cloud, networking, and AI portfolios.

In a recent letter to investors, Krishna said, “Hybrid cloud and AI are the two next great shifts in the technology landscape, and IBM is positioning itself to play a key role in this swift and massive transformation. We see the hybrid cloud opportunity at $1 trillion.”

A key variable in the cloud landscape is the ability to work with multiple platforms, an ability that was strengthened with the acquisition of open-source pioneer Red Hat.  

IBM’s multicloud path forward

At the time of the Red Hat acquisition, IBM noted that its cloud revenue had grown from a paltry 4% of total revenue to a healthy 25% by 2019. IBM said that it expected the Red Hat acquisition to add “approximately two points of compound annual revenue growth to IBM over a five-year period.”

Those predictions began to come true quickly. In 2022, Tom Rosamilia, who was then IBM’s SVP of Software, described Red Hat as the linchpin of IBM’s multicloud capabilities.

“The reason we spent $34 billion to acquire Red Hat was to get OpenShift, so we could rebase our entire software portfolio on OpenShift and move it to a container model and move it so it can run anywhere,” Rosamilia said. By rebasing IBM’s Cloud Paks on OpenShift, IBM has been able to create a middleware environment that enables IBM’s Cloud Paks to be deployed on IBM Cloud, AWS, Azure, or on-premises.

IBM’s bet that hybrid cloud, rather than all-cloud, would be the operating model most enterprises would settle on, is also paying off.

“Five years ago, we were fighting an uphill battle, talking about hybrid cloud as a destination. Everybody said it was a point along the way,” Rosamilia said. “Nowadays, we have zero of those conversations. Everybody accepts the fact that some of their workloads will remain on-premises, and they need to modernize it.”

Rosamilia contends that the days of “everything will go to the public cloud” are over. For governance, security, and cost reasons, hybrid multiclouds will be the norm, not a weigh station along the road to an all-public cloud network.

To further its multicloud vision, IBM recently made another strategic hybrid cloud acquisition, announcing on April 24 its intention to purchase HashiCorp, a multicloud infrastructure automation company, for $35 per share in cash (approximately $6.4 billion). The transaction is expected to close by the end of 2024. As with Red Hat before it, HashiCorp brings along an extensive roster of existing clients. Its more than 4,400 customers include Bloomberg, Comcast, Deutsche Bank, GitHub, J.P Morgan Chase, Starbucks, and Vodafone.

HashiCorp’s flagship service, Terraform, enables automated provisioning and lifecycle management for infrastructure and security in heterogeneous, multicloud environments. According to IBM, when combined with IBM and Red Hat, HashiCorp will give clients a platform capable of automating the deployment and orchestration of workloads across evolving infrastructure, including hyperscale cloud service providers, private clouds, and on-premises environments.

Why many feared IBM would take Red Hat in wrong direction

At the time of the Red Hat acquisition, reactions to the deal were mixed. Several existing customers that were working with both companies chimed in with public support, including senior executives from Delta Airlines and Morgan Stanley.

IDC analyst Frank Gens was also bullish on the deal, predicting that an independent Red Hat operating under IBM’s umbrella would deliver big benefits for both organizations. “Over the next five years, IDC expects enterprises to invest heavily in their journeys to the cloud, and innovation on it. A large and increasing portion of this investment will be on open hybrid and multicloud environments that enable them to move apps, data and workloads across different environments,” Gens said. “With the acquisition of Red Hat, and IBM’s commitment to Red Hat’s independence, IBM is well positioned to help enterprises differentiate themselves in their industry by capitalizing on open source in this emerging hybrid and multicloud world.”

Detractors, on the other hand, worried that IBM’s legacy baggage would weigh down Red Hat. If you spend even a few minutes scrolling through r/redhat, you’ll find plenty of harsh critiques of the deal both then and now from developers and Red Hat users.

Critics also worried that IBM would undercut Red Hat’s culture. After all, IBM is famous for its staid, blue-suit posture that doesn’t exactly align with Red Hat’s more freewheeling ways.

But Krishna reassured critics that IBM would respect Red Hat’s independence and avoid “blue washing” its purchase. “I think if anything there may be more of a pale red rinse on IBM than a blue wash on Red Hat,” he said back in 2019.

IBM buying spree isn’t over

Red Hat and IBM already had a history of both competing against and partnering with each other on major cloud deployments, and the combined company stressed that it would continue to operate in this fashion. The two companies have also been strong advocates for open-source software, and with Red Hat’s experience monetizing open-source technologies, such as Linux, Kubernetes, Ceph, and more, the IBM-Red Hat combo could help spread open-source further throughout cloud infrastructure, while also offering a way out of cloud vendor lock.

Not all partners, customers, and employees were thrilled with the newly combined company, however. Red Hat’s hometown newspaper in Raleigh, N.C., ran a series of articles channeling the local fear that IBM would inevitably transform Red Hat into a different sort of organization, stripping it of its more innovative impulses. The negative sentiments accelerated last year when Red Hat laid off approximately 4% of its workforce. Critics warned that this marked the beginning of the end of Red Hat’s rebel culture.

Yet, when IBM acquired Red Hat, the open-source organization was generating annual revenues of $3.3 billion. Now, under IBM’s wing, Red Hat-driven cloud software revenues hit $7.5 billion in Q4 2023, a 3.1% increase from the year prior and a continuation of a trend of steady growth that makes the high sticker price for this acquisition look reasonable.   

Expect IBM to continue adding to its cloud platform with more acquisitions this year, and not just splashy ones, such as with the multibillion-dollar HashiCorp acquisition, but also with small tuck-in acquisitions. Rosamilia said that IBM has made more than twenty tuck-in acquisitions since 2020, buying up everything from drive-thru technology to in-vehicle dashboard software.

CFO Jim Kavanaugh says that this strategy would continue for the foreseeable future. “You’re going to continue to see us be opportunistic in the marketplace,” he said, noting that IBM intends to continue to acquire more cloud- and AI-related companies, seeking out a “strategic fit for a hybrid cloud and AI-platform-centric company.”

Buying up the competition is nothing new. When innovative competitors have threatened them, plenty of other massive incumbents, including Cisco, Microsoft, and Google, have acquired companies not just to plug gaps in their portfolios, but also to claw their way back to relevance.

There’s an old saying in tech circles: Nobody ever got fired by buying IBM. That wisdom was falling out of favor, with the sentiment often shifting to competitors like Cisco and Microsoft. Now, powered by a two-headed AI and multicloud behemoth, IBM looks like it has become not just a safe cloud bet, but also a smart one. 

(Jeff Vance is the founder of Startup50.com, a site that discovers, analyzes, and ranks tech startups. Follow him on Twitter, @JWVance, or connect with him on LinkedIn.)