Posts

Canonical doubles down on multicloud in defense of its strategic position against Red Hat and VMware

TBR perspective

At Canonical’s 2019 Analyst Day, the company displayed a compelling business model and a clear road map toward achieving its desired business outcomes. However, TBR believes the long strategic strides Canonical has taken over the past year have only propelled the company so far due to the increasingly competitive field that Red Hat and VMware (NYSE: VMware) are creating. It has been just over two months since IBM (NYSE: IBM) completed its purchase of Red Hat, so it was not a surprise that Canonical emphasized the competitive landscape IBM has shifted with its $34 billion purchase. Even less surprising was Canonical’s dive into specific areas, including public cloud and data center, where it expects to sidestep its two biggest competitors, Red Hat and VMware, both of which Canonical is also most often compared to within the market.  

Navigating a competitive landscape

While Canonical boasts that its multicloud strategy is unique, the vendor’s approach to multicloud aligns with that of major public cloud providers as Canonical aims to run Kubernetes on its Linux-based operating system (OS), Ubuntu, to solidify its place at the interoperability layer. In his opening remarks, Shuttleworth alluded to the fact that open infrastructure is just beginning and that the pending explosion of open source will occur at the applications layer; on top of that, Canonical claims PaaS will not account for more than 10% of applications. TBR believes Shuttleworth’s comments take direct aim at VMware Cloud Foundry and the fact that VMware does not own any applications. However, while Canonical boasts that its approach goes beyond infrastructure with its Linux app store, VMware is close behind given its recent acquisition of Bitnami, which specializes in application packaging, supporting VMware’s application ecosystem strategy.

As one of the few remaining OpenStack providers, Canonical has positioned its proprietary OpenStack offering, BootStack, to still be very much part of the company’s value proposition while other vendors like IBM, Rackspace and Mirantis are de-emphasizing the technology. As part of its private cloud strategy, Canonical maintains support for OpenStack private clouds on Ubuntu, whereas in public cloud Canonical places Ubuntu on the platforms of partners, such as Amazon Web Services (AWS; Nasdaq: AMZN), Microsoft (Nasdaq: MSFT), Google (Nasdaq: GOOGL), Oracle (NYSE: ORCL), Rackspace and IBM. TBR expects IBM will shift its current Ubuntu-based workloads to Red Hat Enterprise Linux (RHEL) now that its purchase of Red Hat is finalized, resulting in the loss of business for Canonical. Presentation materials also highlighted opportunity around fully managed infrastructure services. TBR notes the managed services opportunity around OpenStack was far more prominent 10 years ago, whereas now the opportunity is around creating a managed services portfolio that emphasizes higher-complexity workloads as well as IoT. Canonical noted it is not attempting to build a managed services empire, yet further development in this area presents an uphill battle for the company, especially as IaaS leaders AWS, Microsoft and Google make it easier for enterprises to navigate the challenges of a hybrid environment, which in many cases OpenStack cannot serve.

At Canonical’s 2019 Analyst Day, CEO Mark Shuttleworth and other company executives got together with industry analysts to highlight the company’s revamped business strategy, one that emphasizes four competitive battlegrounds including public cloud, data center, edge cluster and IoT. The event featured presentations from Shuttleworth, Finance Director Seb Butter and VP of Public Cloud Christian Reis, among others. The event also incorporated presentations from key partners, including from Atos VP of Cloud Engineering Bob Seddigh and BT Group Chief Architect Neil McRae.

Streamline and extend: IBM’s play for what it calls ‘hybrid multicloud’ or ‘Chapter 2 of the Cloud’

IBM will use OpenShift to bring a consistent cloud value proposition, remaining agnostic toward delivery method, location or cloud provider

In 2015 Red Hat’s CEO made a statement at an analyst day presentation that Red Hat aimed to do to the PaaS layer with OpenShift what it had done to the enterprise operating system layer with RHEL. That strategy was thoroughly validated with IBM’s acquisition of Red Hat. At the core of the IBM Cloud Summit were discussions of how OpenShift was the only platform layer capable of running on multiple clouds, in what IBM describes as hybrid multicloud. In IBM’s definition, hybrid denotes the ability to run applications on premises, in private clouds, in public clouds and at the edge. Multicloud denotes the ability to mix and match different cloud providers across the hybrid continuum. Many vendors can deliver single brand — or monocloud — hybrid that is a new version of vendor lock-in. IBM asserts OpenShift is the only cloud operating system and development layer that can enable customers to code once and deploy on any form factor from any technology vendor.

Stefanie Chiras, VP and general manager of the RHEL Business Unit, articulated the central Red Hat value proposition as being an enterprise software company with an open-source development model. Involved in a variety of different open-source projects, Red Hat monitors these myriad projects, filtering the most powerful innovations from these upstream contributions into the RHEL operating system before hardening these projects into enterprise-grade products and adding the necessary security and DevOps deployment features needed for large enterprises.

This hardened curation of open-source community projects has seen Kubernetes container management rapidly emerge as a de facto deployment standard, which has Linux as the underpinning operating system. OpenShift stitches RHEL and Kubernetes together with additional development services, and IBM will pivot all its software into cloud-native deployment models resting on top of this foundation to enable the software to run anywhere its customers require.

IBM bets on Cloud Paks to simplify application modernization migration to the cloud in what it calls the ‘second chapter’

IBM’s point of view is that the cloud is entering its second chapter. In the first chapter, which has been the last 15 years, enterprises have moved some development and some customer-facing applications to the cloud, but the deep back-office systems of record have remained on premises for a variety of reasons, including the technical debt of the custom applications, as well as concerns around security and compliance.

Cloud Paks are the manifestation of three to five years of ongoing development work to refactor their monolithic middleware applications into containerized, cloud-ready services. From a packaging standpoint, the Paks simplify the sprawling IBM middleware portfolio into pre-integrated solutions that address the most pressing challenges to cloud migration and operations. All Cloud Paks sit atop RHEL and OpenShift, with IBM promising “single button push deployment” when running applications on the IBM Cloud. Being underpinned by RHEL and by OpenShift maintains infrastructure independence and enables enterprise customers the ability to choose any vendor cloud or underlying on-premises infrastructure to run these applications anywhere.

The IBM Cloud Summit 2019 combined several main IBM initiatives into a full day of executive presentations for the analyst community. IBM’s presentations on strategy and innovation centered on the opportunity to migrate 80% of the workloads still run by traditional IT delivery methods to the cloud. IBM’s legacy strengths, combined with more recent investments, make the company well suited to help customers address the remaining 80% of IT workloads, most of which are mission critical. IBM’s recent landmark investment was the purchase of Red Hat, and IBM laid out in even greater detail how that will benefit customers. This was followed by a series of presentations taking aim at the untapped market opportunity as well as the various middleware services and professional services IBM can bring to bear on the application migration and modernization efforts for its customers resting on the foundational elements of Red Hat Enterprise Linux (RHEL), Red Hat OpenShift and Kubernetes container management clusters.

Red Hat builds the digital transformation autobahn, where developers are king of the road

Red Hat production systems curate community IP into a simplified horizontal platform, paving the way for scaled innovation

In a 2015 conference for financial analysts, Red Hat CEO Jim Whitehurst declared victory in commoditizing the enterprise OS market into RHEL and Windows Server, while outlining Red Hat’s intentions to do the same thing to the (then) emerging PaaS layer with OpenShift.

The closing guest speaker during the Red Hat keynote address at the 2019 summit was Microsoft (Nasdaq: MSFT) CEO Satya Nadella, who announced Azure Red Hat OpenShift. While it might still be premature to declare victory in fulfilling that aspirational objective from 2015, it certainly can be said that Red Hat has made significant progress in a short period of time.

RHEL and OpenShift represent the curation pillars for open upstream community innovations, coupled with Red Hat’s decades of open-source and service experience to deliver a capabilities-based advantage to its users. Red Hat represents the virtuous cycle of trusted platform delivery, user-contributed innovations, and Red Hat production-grade delivery of those innovations back to the community via a platform layer that is increasingly easier to deploy.

RHEL 8 delivers additional simplicity and automation capabilities to allow operators to better facilitate developer innovation

Red Hat heralds RHEL 8 as a significant improvement over RHEL 7, best illustrated by the fact that the upgrade process to RHEL 8 constitutes a simple point-and-click operation, after which automation can take over the rest of the process in seamless fashion.The latest release is said to be designed for applications to run across open hybrid cloud environments, addressing the enterprise hybrid reality. Before its official release to market at the summit, there were over 40,000 downloads of RHEL 8 in beta, which underscores pent-up demand for the release and also helped Red Hat to enhance the operating system based on invaluable feedback from those beta users.

TBR attended the Red Hat (NYSE: RHT) Summit, which featured the usual slew of product announcements. This year, the company focused intently on enhancements to Red Hat Enterprise Linux (RHEL) 8 and Red Hat OpenShift 4, which are the foundational products for the enterprise. However, more interesting were the general discussions throughout the summit about Red Hat’s business model and cultural uniqueness, which contribute to the company’s success in curating openly sourced IP into enterprise-grade technology products underpinning an ever-increasing share of business software. The value of its people and processes were regularly emphasized by reminding attendees that IBM (NYSE: IBM) is paying $34 billion for a $3.2 billion company that owns no IP.

Big Blue opens its arms, and its wallet, to Red Hat

On Oct. 28, IBM (NYSE: IBM) and Red Hat (NYSE: RHT) executives announced a proposed acquisition ― one that will be the industry’s third-largest acquisition should it gain approval. The deal, valued at $34 billion, would bring Red Hat into IBM’s hybrid cloud team, in its Technology Services and Cloud Platforms (TS&CP) group, where its IaaS (formerly SoftLayer), PaaS (formerly Bluemix) and hybrid management capabilities reside.

Sticker shock fades once you factor in the rest of the numbers

Historically, initial public offerings (IPOs) and sales of more traditional technology and software companies have been valued at around 5x their annual revenue. However, in recent years, as more cloud-native companies with subscription-based business models go public or get acquired, this multiple has steadily shifted upward. As a rather extreme example, Cisco (Nasdaq: CSCO) bought AppDynamics for $3.7 billion, a valuation of nearly 16x AppDynamics’ annual revenue, even though in the week prior to the purchase AppDynamics had been valued at $1.9 billion on an annual revenue of approximately $220 million as the company readied for its IPO.

Much of the speculation around this monstrous deal relates to how IBM can and will fund such a hefty purchase. To put this massive $34 billion figure into perspective, Red Hat’s trailing 12-month revenue for the four quarters ended Aug. 31, 2018, was just shy of $3.1 billion, indicating the deal is valued at 11x Red Hat’s annual revenue. Figure 1 shows that if Red Hat were to stay on its double-digit growth pattern and trajectory*, its revenue and operating income would be projected to more than double by the close of 2021, benefiting from access to IBM’s vast enterprise customer base.

Estimated revenue, year-to-year growth, operating margin and more for 2018 through 2021

These projections help IBM justify the large purchase price. Additionally, it is likely that the purchase price per share was set at least a few weeks ago, when there were more Red Hat shares available and at a higher price. On Oct. 1, Red Hat was trading at $133 a share, compared to the $117 per share price it was trading at on Oct. 26.

Big Blue opens its arms, and its wallet, to Red Hat

Red Hat’s projected growth is enough to justify the hefty purchase price

On Oct. 28, IBM (NYSE: IBM) and Red Hat (NYSE: RHT) executives announced a proposed acquisition ― one that will be the industry’s third-largest acquisition should it gain approval. The deal, valued at $34 billion, would bring Red Hat into IBM’s hybrid cloud team, in its Technology Services and Cloud Platforms (TS&CP) group, where its IaaS (formerly SoftLayer), PaaS (formerly Bluemix) and hybrid management capabilities reside.

While the sheer magnitude of the deal may surprise some, the underlying reasons do not. IBM’s cloud strategy was sorely due for a boost, and Red Hat has been looking for a potential buyer for quite some time. Stefanie Chiras, a 17-year IBM vet, joined Red Hat as the VP and general manager of the Red Hat Enterprise Linux (RHEL) business unit in July, likely to lead that group through the planned acquisition. The potential acquisition would also be aided by portfolio synergies around Linux on IBM hardware and Kubernetes. Additionally, IBM is pervasive in the large enterprise market while much of Red Hat’s revenue is channel-led.

What’s most important is that IBM listened to its stakeholders and the broader market, realizing that while its cloud business was growing consistently at around 20% to 25% year-to-year on a quarterly basis, that was not enough to move the needle materially to more effectively compete in cloud. The company’s recognition that it should not always promote all-IBM solutions is a noteworthy shift. Though IBM has had technology partnerships for some time, there was always the underlying perception that it would push its own solutions ahead of others, regardless of customer needs. Its recent and ongoing focus on hybrid IT enablement has changed this; and now, bringing on an open-source company could change the game for IBM.

Sticker shock fades once you factor in the rest of the numbers

Historically, initial public offerings (IPOs) and sales of more traditional technology and software companies have been valued at around 5x their annual revenue. However, in recent years, as more cloud-native companies with subscription-based business models go public or get acquired, this multiple has steadily shifted upward. As a rather extreme example, Cisco (Nasdaq: CSCO) bought AppDynamics for $3.7 billion, a valuation of nearly 16x AppDynamics’ annual revenue, even though in the week prior to the purchase AppDynamics had been valued at $1.9 billion on an annual revenue of approximately $220 million as the company readied for its IPO.
Much of the speculation around this monstrous deal relates to how IBM can and will fund such a hefty purchase. To put this massive $34 billion figure into perspective, Red Hat’s trailing 12-month revenue for the four quarters ended Aug. 31, 2018, was just shy of $3.1 billion, indicating the deal is valued at 11x Red Hat’s annual revenue. Figure 1 shows that if Red Hat were to stay on its double-digit growth pattern and trajectory*, its revenue and operating income would be projected to more than double by the close of 2021, benefiting from access to IBM’s vast enterprise customer base.

Estimates for revenue, year-to-year growth, operating income and more for 2018 through 2021

These projections help IBM justify the large purchase price. Additionally, it is likely that the purchase price per share was set at least a few weeks ago, when there were more Red Hat shares available and at a higher price. On Oct. 1, Red Hat was trading at $133 a share, compared to the $117 per share price it was trading at on Oct. 26.

Synergies make the acquisition possible; success will come down to execution

Organizational structure

The proposed acquisition poses significant integration challenges for IBM if approved. Though the company has been successful in the past with integrating software acquisitions, it has yet to make a purchase this large, and this is the first major software acquisition since the company reorganized and brought software subgroups across its various business units a couple of years ago, eliminating a dedicated software business unit. Additionally, none of the formerly acquired companies have run as stand-alone units as Red Hat is expected to be.

Red Hat’s proposed position as a stand-alone unit in TS&CP could have varying results. IBM Services’ culture and cumbersome processes could stifle Red Hat’s software-led mindset, culture and innovation. Alternatively, Red Hat’s products could be pulled through in an unprecedented number of Services engagements the company has yet to see due to its much smaller size and scale. This second scenario, however, would only be possible if IBM Services and consultants can differentiate from Red Hat’s existing systems integration partners to maintain IBM’s status as the largest services provider around Red Hat and Linux. Whether or not those partnerships will stay at the strategic levels they are at today, or at all, remains unclear.

Red Hat CEO Jim Whitehurst would report to IBM CEO Ginni Rometty. While it is very likely he would stay with IBM for the year or so required and then retire, there is the possibility, and this is pure speculation, that IBM could be priming him to be a contender for the position of IBM CEO should Rometty look to retire soon.

Go to market

Undoubtedly, IBM has set its sights on reaching more midmarket customers as its large enterprise customer base is slower and more resistant to move to cloud. Red Hat’s prevalence in the midmarket will surely help open the doors to cross-sell IBM solutions and services to these companies, if pricing is adjusted for smaller companies. Additionally, IBM will gain access to a Red Hat developer community of more than 8 million. On the other side of this, Red Hat also can bring its solutions upmarket to IBM’s largest enterprise customers.

Much of IBM’s focus as of late has been on helping customers link on- and off-premises environments and sharing data across truly hybrid environments. Its large Services arm and broad portfolio set have helped offset some legacy software and services revenue erosion in past quarters. While Linux is already relatively pervasive across the market and OpenStack has yet to garner significant demand or traction, Kubernetes is the open-source solution of choice at the moment and will be in coming quarters. IBM continues to update its IBM Cloud Private portfolio centered on Kubernetes, which can also run on OpenShift, presenting an area of immediate portfolio synergy between the two companies. The incorporation of additional open-source technologies into the mix as well as Red Hat’s interoperability with third-party cloud and software solutions only help position IBM as an increasingly technology-agnostic hybrid enabler.

Peer implications

Despite the size of the acquisition and the attention it is garnering, IBM’s cloud competitors will not face substantially altered challenges should the deal go through. Amazon Web Services (AWS) and Microsoft (Nasdaq: MSFT) will continue to dominate the public cloud IaaS and PaaS market. The two have increasingly embraced open-source technology integrations in their proprietary ecosystems, only enabling them to get bigger as they can also work with RHEL customers.

We believe that if this acquisition were to materially impact any single company, it could be Google (Nasdaq: GOOGL) and/or Oracle (NYSE: ORCL). Google struggles to compete at scale with AWS and Microsoft and does not yet have the same permission to play in the large enterprise segment. With IBM, Red Hat would gain that permission almost immediately. Oracle’s Linux offerings are based on RHEL, which could complicate a competitive relationship between IBM and Oracle. While Oracle may have more pressing areas to focus on and invest in, such as Kubernetes in tandem with its peers, the company could, should it choose not to work closely with IBM when Red Hat is integrated, look to acquire another Red Hat-like company with expertise and capabilities in open source and Linux in particular, such as Canonical or SUSE, which was just sold by Micro Focus (NYSE: MFGP) to private equity firm EQT for $2.5 billion.