RALEIGH – As the countdown to regulatory approval for IBM’s $34 billion acquisition of Raleigh-based Red Hat, a lot of questions remain unanswered about what will be the true consequences, not what company executives have said.
Will Red Hat (NYSE: RHT) really remain separate from IBM (NYSE: IBM)?
Will there be layoffs as there are in most corporate mergers as companies look for so-called “synergies” such as human resources, financial and back-office support in order to cut costs?
Will Red Hat executives stay on board once stipulations in the deal regarding retention in order to receive restricted stock options expire?
Veteran tech attorney Jim Verdonik, who deals on average with multiple mergers-and-acquisitions a year, reached out to some colleagues and responded to queries from WRAL TechWire about the deal, which received approval from the European Union as early as today. Regulators in the US and Brazil have already signed off on the transaction.
“Theoretically, they can have very separate operations. However, most people think IBM overpaid for Red Hat as a standalone business,” Verdonik said of the deal – the biggest ever in North Carolina – was announced last October.
IBM had to go to the bond market to raise $20 billion to help cover the cost of the acquisition.
“That price ($190 in cash for each share) only makes sense if IBM sees a lot of synergies between the two businesses,” Verdonik added. “It’s difficult to reap the benefits of synergies if the two businesses really do operate separately.
“So, I don’t believe what I read about separate operations.”
When the deal was first announced, speculation stirred that Red Hat CEO Jim Whitehurst would be in position to replace IBM Chair and CEO Ginni Rometty. He will, after all, answer directly to her as part of Red Hat’s insistence that it remain separate from IBM’s sprawling global operations.
What really will happen?
“As for Red Hat’s top management, maybe [they retain autonomy],” Verdonik says.
“Maybe they retain autonomy.”
“Maybe they take over IBM.”
“Maybe they find themselves out on the street.”
“Maybe they start new businesses.”
“Only time will tell.
“The biggest local acquisition I can remember is the Duke Power and Progress Energy. As I recall, the deal on paper was that Progress CEO [Bill Johnston] was supposed to run the combined company. That ended before the ink was dry on the acquisition signatures.
“I’m not forecasting that here. It’s just an example of the principle that reality has a way of prevailing over legal documents.”
Verdonik doesn’t expect layoffs at Red Hat – but what about the other way around?
IBM recently acknowledged cutting 1,700 jobs and also has sold off some smaller business operations.
“I don’t know how this may affect IBM employees,” Verdonik notes. “I would be a little more worried about layoffs if I worked for IBM. IBM recently borrowed $20 Billion to pay for Red Hat. That debt service might cause IBM to do some cost cutting.”
As for Red Hat, Verdonik says the problem may be keeping employees from cashing out stock and leaving – as well as being recruited.
“For a company like Red Hat, a big part of their value is their employees,” Verdonik explains. “Most businesses in the software industry are scrambling to recruit people.
“I wouldn’t be worried about layoffs if I was a Red Hat employee.”
“The opposite is more likely,” Verdonik warns. “Headhunters will be raiding Red Hat to recruit their best people for other companies. The headhunters will play on fears that things will change at Red Hat.
“Also, because the IBM deal was announced so long ago, employees who may have wanted to take positions with other companies have probably been frozen in place. They don’t want to lose part the benefit of the buyout by quitting before the deal closes. So, I think Red Hat will have to work to retain people rather than layoff people.
INTEGRATION MEETINGS BEFORE THE CLOSING
Whitehurst has noted that Red Hat and IBM teams have had meetings to discuss how the merger will be executed. But Verdonik wonders how much of anything has been accomplished.
“Red Hat and IBM need to be a little concerned abut not colluding with one another before the deal closes,” he says. “That could raise antitrust concerns.
“Also, until they close, neither company wants to share secrets about customers. It’s always possible that the closing won’t occur. The saying is that the Opera isn’t over until the fat lady sings. That said, if they want synergies, they have to be doing some behind the scenes planning.”
LOCKUPs and RETENTION
So who stays at Red Hat because they don’t have a choice or who will bolt?
“Retention is always an issue. Red Hat’s management appears to be getting cashed out,” Verdonik says, noting recent says. ” In this case cash retention bonuses seems to be the retention tool of choice.”
For example, Whitehurst is among those locked in for terms longer than a year. His agreement is for three with $15 million in stock at stake.
According to a filing:
“Mr. Whitehurst’s retention arrangement provides that he will receive a new award of IBM restricted stock units with a grant date fair value as of the closing equal to $15,000,000. This restricted stock unit award vests one-third on the third anniversary of the closing and two-thirds on the fourth anniversary of the closing, subject to Mr. Whitehurst’s continued employment, and is not subject to accelerated vesting.”