International Business Machines Corp.’s (IBM) blockbuster deal to acquire open-source software provider Red Hat for $34 billion could trigger a wave of similar takeovers. That’s the perspective of JPMorgan Chase software analyst Sterling Auty who, in a note to clients earlier this week, suggested six other software companies that could become potential targets following the IBM-Red Hat deal. Those six companies include, Okta Inc. (OKTA), Palo Alto Networks Inc. (PANW), ServiceNow Inc. (NOW), RingCentral Inc. (RNG), Aspen Technology Inc. (AZPN), and DocuSign Inc. (DOCU), according to Barron’s.
6 Software Stocks That May Post Big Gains
|Palo Alto Networks||$16.76 billion|
|Aspen Technology||$5.79 billion|
Source: Barron’s, Yahoo! Finance, as of 4pm EST 10/30
“These names offer truly unique solutions and/or dominant market share in spaces that have attractive long-term opportunities,” Auty noted.
What It Means
The incentive for IBM in acquiring Red Hat is to gain a leading position in the hybrid cloud market, a market catering to companies with both on-premise and cloud-computing data needs. With IBM showing its seriousness in become a leading cloud provider, rival firms are likely to follow suit, looking to bolster their own ventures into the cloud. The six firms suggested by Auty could allow potential acquirers to do just that as well as enter into other blossoming technology markets.
IBM Paying Big for Red Hat
|$34 billion deal.|
|55x Red Hat's expected forward earnings.|
|10x Red Hat's trailing 12-month sales.|
Okta, for example, is a “best in class” cloud-identity software provider, offering solutions for companies looking to move corporate applications onto the cloud. The enterprise-software firm is up 3% since Friday’s close after the IBM-Red Hat deal was announced on Sunday.
IBM’s takeover of Red Hat comes amid a merger and acquisition (M&A) boom in software this year, with as much as $406.9 billion worth of software deals signed worldwide since the start of 2018. But the IBM-Red Hat deal is being considered one of the more richly valued of recent software deals. Considering the $34 billion price tag works out to about 10 times Red Hat’s trailing 12-month sales, senior vice president for technology M&A at EY Derek van der Plaat said, “I think it’s a pricey deal,” noting that software companies have historically sold for about 4.5 times sales.
While speculation is likely to continue for some time as to whether the deal will eventually payoff, the rich valuation may be a caution for would-be acquirers in the software space right now. It may be worth waiting for the M&A boom to cool a bit, especially considering the plunge in markets this month, with the tech sector being particularly hard hit. Of course, a moderately valued target in a niche market probably won’t last long as firms look to bolster their software profiles.