CORRECTED-RPT-BREAKINGVIEWS-IBM’s $11 bln deal could make it an AI cockroach

The author is a Reuters Breakingviews columnist. The opinions expressed are his own. Corrects chart note to say that data begins in 2022, not 2025.

By Pranav Kiran

TORONTO, Dec 8 (Reuters Breakingviews) - For IBM IBM.N, comparisons to a cockroach might be flattering. The technology centenarian lagged younger rivals like Google GOOGL.O, Microsoft MSFT.O and Amazon.com AMZN.O during the early, heady growth of the cloud era. As the chatbot age re-scrambles industry fortunes, though, boss Arvind Krishna has embarked on a dealmaking spree to bolt together a newly resilient business providing the technological plumbing for machine learning. His latest addition, Confluent, could help IBM further mimic some insectile tenacity.

The deal, announced on Monday, looks wanting under conventional financial logic. Take Confluent’s CFLT.O $129 million of expected operating income for the coming year, according to Visible Alpha data, along with estimated synergies of about $500 million, tax them, and the implied return on invested capital would be just over a paltry 4%. The silver lining is that the present value of those synergies, once capitalized, does at least exceed the premium being paid.

Yet these short-term expectations elide the advantages of picking up enterprise software companies trading in the dumps after falling out of favor with investors. Confluent is selling for less than its initial public offering price back in 2021, after its stock slid and then flatlined for years. Nonetheless, its products help clients build pipelines to guide ever-swelling floods of data about, crucial for AI applications. Its revenue is expanding twice as quickly as IBM’s software segment, which Krishna has been trying to grow. While immediate profitability is weak, the company's free cash flow is expected to more than double in the three financial years to 2028.

IBM is returning to its roots in a sense. In a previous technological epoch, the company’s mainframes were the default of computational infrastructure. Though it spun off mainframe-services business Kyndryl in 2021, a string of deals since 2019 for Red Hat, HashiCorp and now Confluent is designed to recreate something similar for AI.

As a result of that makeover, IBM’s high-margin software unit is now its largest. This has helped to win a newly generous $290 billion valuation. The company’s shares trade at about 30 times next year's earnings, closer to the so-called magnificent seven that supplanted Krishna’s company atop the tech hierarchy than to the IT services firms, like Accenture and Tata Consultancy Services, with which it had begun to be grouped. Much like the humble cockroach, IBM has a way of just hanging in there.

CONTEXT NEWS

IBM said on December 8 that it had agreed to acquire data infrastructure company Confluent in a deal that values the seller’s enterprise at $11 billion. The offer price of $31 per share represents a premium of around 34% to Confluent’s last closing price.

Confluent was exploring a sale after attracting acquisition interest, Reuters reported on October 7, citing sources familiar with the matter.

(Editing by Jonathan Guilford; Production by Maya Nandhini)

((For previous columns by the author, Reuters customers can click on KIRAN/pranavkiran.t@thomsonreuters.com))