IBM Common Stock (NYSE:IBM) was naturally the star of the financial media on Monday. In case you missed it, the company gobbled up Red Hat (RHT), the North Carolina based cloud computing play, for $190 per share in cash, representing a total enterprise value of approximately $34 bln — a whopping 63% premium from RHT’s $116.68 closing price on Friday.
Like it or hate it, you have to take note of it. It’s a big deal. Most commentators reacted in one of two ways. It was either “IBM just patched up their topline growth hole with an acceleration to the cloud business that should pay off in spades over coming quarters!”, or it was “Oh my. What happened there? This is a terrible deal for IBM. It looks desperate after the Street saw the Q3 numbers and realized the cloud/AI bundle direction just wasn’t working.”
IBM Common Stock (NYSE:IBM) did the deal, whatever you may think of it.
On its face, it makes sense that they want to add some juice to the cloud business because that’s the high-growth component to the model right now. And that was missing (as we covered here).
However, overpaying at the top of the cycle (quite possibly?) isn’t necessarily the solution to anyone’s problems.
That said, what we found most interesting was the fact that RHT traded all day at a 10% discount to the deal price. So, we wanted to look at why that might be.
The answer, as we see it, highlights the macro situation.
So, both Red Hat and IBM do significant business in China. And, to get the deal through, both sides have to consider all of their major markets. As such, a merger of this size generally has to pass muster with regulatory officials basically everywhere, but especially in the must-have markets.
In this case, that means the US, EU, China, and Japan.
With this type of deal, generally speaking, when both companies are based in the same country, decorum and tradition say that no one is going to block the deal if the home country is okay with it. It’s sort of an unwritten rule.
However, given the extraordinary tension between China and the US right now, one might think that the Chinese could block the deal – or at least, make it a bargaining chip in the ongoing feud between Beijing and DC.
However, when the deal was announced, IBM tweeted out that the nature of the deal did not require Chinese approval given stated policies.
So, why did RHT spend all day at 10% under the deal price? Our understanding is that the lack of this requirement is not a fixed idea. A rule change could come into place to make this subject to Chinese regulatory authority if they should so choose.
But the biggest issue is the fact that the deal is not scheduled to close until Q4 2019.
With the way the US-China relationship is trending right now, that’s an awfully long time to wait.
In addition, if the market environment deteriorates between now and then, a slow-growing IBM could start to choke on this one.
In short, the arb game is going to be active with this one for several reasons. And we wouldn’t expect to see RHT at $190 until at least 12 months from now. And, in our present geopolitical and macro context, that’s an awfully long time to wait.