Why Microsoft Should buy Red Hat

Some background: Matt asked "Why doesn't Oracle just buy Red Hat?" I explained why Oracle would not buy Red Hat Luis Villa replied to Matt's question: "Because Red Hat employees would leave en masse." Microsoft announced fiscal 4Q07 growth of 13% on Thursday (or 16% if you only count their true software revenue - which falls into the "Client", "Server & Tools" and "Microsoft Business Division" reporting cate

Some background:

  1. Matt asked "Why doesn't Oracle just buy Red Hat?"
  2. I explained why Oracle would not buy Red Hat
  3. Luis Villa replied to Matt's question: "Because Red Hat employees would leave en masse."
  4. Microsoft announced fiscal 4Q07 growth of 13% on Thursday (or 16% if you only count their true software revenue - which falls into the "Client", "Server & Tools" and "Microsoft Business Division" reporting categories). Microsoft crossed the $50 billion total year revenue mark with the close of fiscal 2007.
  5. I compared Red Hat's stock performance over the past year vs. some Traditional software vendors (see below)
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If you're still with me....

Red Hat is growing and executing well. Financial analysts expect Red Hat to hit $517M this year (fiscal 2008, ending Feb. 2008), and $631M in fiscal 2009. At this pace, Red Hat should cross the $1 billion revenue mark in fiscal 2011. Red Hat may well be the gorilla in the Open Source marketplace. But after everything is said and done, that marketplace is tiny in comparison to the total software market. If you believe in the stock market's ability to predict a company's future value, one could argue that Red Hat investors are in a "sit tight" mode right now. At a P/E of 72 and PEG of 1.44 (vs. Google's PE of 45 and PEG of 0.99), Red Hat's stock has likely priced in as much growth and "great news" that we could think of. Few doubt Red Hat's position in the overall OSS market, but some may be waking up and asking whether being #1 in 1.8% of the software market is enough to drive the multiples that Red Hat shares enjoy today.

While both vendors have strong operating system franchises, Red Hat isn't really eating into Microsoft's revenues. IDC predicts that the Linux & Windows markets are growing 26% and 9%, with Unix revenues declining by 3% from 2006-2011. Red Hat's Jboss division adds a JEE portfolio that does compete with .NET as the infrastructure for enterprise applications. But here again, it's very unlikely that Microsoft faces off against JBoss in (m)any customer deals. It's more likely that Microsoft competes against IBM WebSphere, BEA WebLogic or Oracle AS, and JBoss only comes into the picture when the customer has already selected JEE. While there is some overlap, Red Hat is much more complimentary to Microsoft's offerings than we'd like to think.

Just imagine a Microsoft that could offer customers a choice of Windows/.NET, Linux/JEE or, and here's the magic, BOTH. The fact is most customers have heterogeneous environments, and those that don't today, will likely in the future.

In the face of OSS competition, one of the best moves we made in the IBM WebSphere division was purchasing Gluecode. As I've mentioned (over and over), having a free application server, based on the open source Apache Geronimo project has done nothing but spur the growth of our overall WebSphere Application Server family. In some cases, the customer chooses WAS CE, in other cases, they choose Traditional WAS products. We help customers be successful with their choice and, equally important, ensure that their previous investments in WebSphere infrastructure are protected. This is exactly the scenario that Microsoft could create for themselves. Microsoft would be able to offer Windows, Linux, .NET or JEE in various combinations to solve customer problems. As a competitor, this would be a scary combination.

What's more, Red Hat could help Microsoft gain OSS street cred almost instantly. To me, this would easily become Red Hat's most important contribution to the software industry. Forget being #1 in 1.8% of the software market. How about helping a $50B software company evolve its thinking around OSS in order to become a $75B software company while increasing customer choice and satisfying customer needs? Goosebumps.

I doubt this acquisition will ever take place for three reasons. First, because of vendors such as IBM, HP, Intel and Oracle who have investments in/with Red Hat. Second, because Microsoft wouldn't want to take the risk. I'd argue that there is much less risk than appears on the surface. Sure, there would be some internal friction during product positioning discussions if the deal went through. But internal friction is healthy and shouldn't get in the way of helping customers succeed with your offerings. Lastly, as Luis' comment highlights, Red Hat's culture would also pose a barrier to this deal. But I’d argue that the only thing that these comments do is put a damper on the deal price, which, at the end of the day, is bad for Red Hat investors. One could argue that JBoss employees felt the same way about Red Hat prior to the acquisition. And yes, some left Red Hat, but some stayed. It would be up to Red Hat management to convince employees about the historic importance of their efforts inside of Microsoft, which would be a pretty compelling reason to stay.

A Red Hat marketing slogan states: "truth happens", what about "change happens"? And why not help Microsoft change?

PS: I truly doubt this deal will ever happen, but it’s interesting to think about the possibilities.

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