Software giant Red Hat gives owner IBM lift to shed its stodgy identity

At IBM’s Investor Day event in New York City this week, the first the company has held since 2021, a word executives stressed was “software.”

And two other words top IBM brass highlighted again and again were “Red Hat.”

“Hopefully you got the theme of the entire day today of us being a much more software-led company,” IBM chief financial officer James Kavanaugh told the audience.

Numbers tell the journey. IBM historically focused on business consulting and manufacturing hardware like servers, storage systems and network equipment. In 2005, software accounted for 18% of the company’s revenue. By 2019, the year IBM acquired the Raleigh software giant Red Hat for $34 billion, software was still only a quarter of its total revenue.

In the past six years however, Red Hat has helped IBM overhaul its portfolio. Kavanaugh told investors Tuesday that software is now 45% of IBM—with the segment projected to soon reach 50%.

“Software is taking the baton from consulting and becoming the key to IBM’s revenue, profit and free cash flow growth over the next three years,” Morgan Stanley analysts wrote in an investor note Wednesday.

Listen to any recent IBM earnings call and the catalyst for this transition is easy to spot.

From 2013 to 2018, IBM recorded 22 consecutive fiscal quarters of declining revenue growth as it struggled to move from traditional hardware—with its one-time sales and fixed equipment costs—toward cloud computing. Red Hat has provided a jolt. Of the 22 quarters since IBM bought Red Hat, the Raleigh company has grown by at least 10% in all but four of them.

“We continue to see momentum in Red Hat with fourth-quarter revenue growth of 17%, fueled by six consecutive quarters of double-digit bookings growth,” Kavanaugh said during the company’s Jan. 29 earnings call.

Since the acquisition, Red Hat’s annual revenue has almost doubled from $3.4 billion to more than $6.5 billion. IBM has in recent years reversed its overall declines, albeit with smaller increases, and its stock is currently near an all-time high.

Beyond hard figures, Red Hat’s addition has coincided with heightened excitement around the parent company. In its latest analyst report, the investment firm BMO Capital Markets said the strong attendance at this year’s Investor Day “reflects incremental interest in IBM compared to historical events.”

Both IBM and Red Hat are major employers in the Triangle. The former has the seventh-largest workforce in Durham County, state records show, with offices in Research Triangle Park, while Red Hat—headquartered in downtown Raleigh—is a top-20 employer in Wake County.

Founded in 1993, Red Hat is the world’s top provider of open source software. The company uses an operating system called Linux, which anyone can access for free. What is sells are bespoke Linux-based packages that enable customers to run their businesses efficiently.

Red Hat’s flagship product is Red Hat Enterprise Linux, or RHEL. The company has also reported significant growth in its hybrid cloud platform OpenShift, which has ballooned from $100 million in annual sales to more than $1.4 billion today.

On last week’s earnings call, IBM CEO Arvind Krishna highlighted the role Red Hat plays as the parent company pursues artificial intelligence. Krishna highlighted how Red Hat software is being paired with Neural Magic, a generative AI firm IBM bought last year.

Yet while AI represents potential, investors say the value Red Hat gives IBM is in its steady subscription-based returns.

In its latest analyst note, the investment firm Melius Research compared the Red Hat acquisition to buying an annuity—an insurance company product that guarantees buyers regular income. Confident that IBM will continue collecting returns, as customer demand for enterprise Linux services appears stable, Melius gave the company a share target of $290—a 12% increase from its current price.

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