IBM is paying a 'rich valuation' for Red Hat (RHT, IBM)

IBM Ginni Rometty

IBM announced Sunday that it has struck a deal to acquire the cloud-software company Red Hat for $34 billion.
IBM said it will pay $190 a share in cash — a more than 60% premium above Red Hat's closing price on Friday.
The "rich valuation" will discourage anyone else to make a higher bid, Jefferies analyst John DiFucci said.
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IBM shares were sliding early Monday, down about 4%, after the tech giant announced on Sunday that it had agreed to acquire the cloud-software company Red Hat for $34 billion.

IBM said it will pay $190 a share in cash — a more than 60% premium to Friday's closing price — for all of Red Hat's outstanding shares. Red Hat shares traded as high as $177.63 apiece in June, but disappointing earnings combined with a volatile market had caused them to drop sharply in recent months. According to IBM, the acquisition was approved by both boards of directors and is subject to Red Hat shareholder approval.

"The acquisition of Red Hat is a game-changer," IBM CEO Ginni Rometty said in a press release. "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."

Jefferies analyst John DiFucci commented that IBM's offer will discourage anyone else to bid higher for this asset.

"Rich valuation likely keeps others on sidelines," DiFucci said in a note sent out to clients on Monday. "At $190 per share, IBM is acquiring Red Hat at an EV/LTM subscription revenue of 12.3x, or 10.7x EV/NTM. We are surprised by this multiple given that historically IBM has been extremely disciplined with its acquisitions."

But DiFucci questioned whether the Red Hat will be able to remain neutral under IBM's control.

"As an Operating System vendor first, its neutrality to all hardware vendors was an important characteristic in our opinion. The IBM acquisition certainly calls that neutrality into question."