IBM Should Buy Cloudera For $5 Billion

Summary

• From a complementary and growth standpoint, Cloudera fits all the criteria IBM should be looking for in an M&A candidate.
• Cloudera can provide IBM — which now owns Red Hat — an immediate leadership position in the Hadoop/Spark ecosystem.
• With $12 billion in cash and marketable short-term investments and long-term marketable securities, IBM can buy Cloudera four times.

When a company with tons of cash, yet short on growth wants to enter new markets, M&A is usually the quickest route to gaining access, and in some cases, market share in industries that would otherwise take years to build. And that seems be the strategy that International Business Machines (NYSE:IBM) has adopted in recent years — albeit unsuccessfully. But now could be an ideal time to buy IBM shares.

The company, affectionately known as “Big Blue,” is now under a new regime, which, in my opinion, has an opportunity finally fix the company’s growth deficiency. I think one of the major steps would be to acquire Cloudera (NYSE:CLDR), which has a strong portfolio of enterprises services for private, hybrid and public cloud platforms - many of which include databases, data processing, AI and machine learning tools.

Buying Cloudera would immediately change IBM's growth trajectory, turning the once-prominent company into precisely what it has marketed itself as - an intelligence think tank. Why now? Shares of Cloudera - a data analytics platform - have been under heavy selling pressure recently, falling as much at 22% in the past three trading days, driven by a combination of factors. Aside from delivering mixed first-quarter earnings results, the management also issued downbeat second-quarter and full-year guidance.

But the main the reason for Cloudera's recent decline could also be what investors believe to be lack of any real suitor. I say “real” because Bloomberg reported that the company has explored a sale “after receiving interest.” According to the report, Cloudera has consulted financial advisors to “evaluate its options.” Without any real substance to the claim, the CLDR stock has pulled back after spiking some 19% Tuesday. Investors have seemingly taken the “fool me once” approach towards the rumors.

There have bee repeated rumors of a sale ever since Robert Bearden’s appointment as CEO in January of this year. This is in part because Bearden has developed a propensity to do deals. Not only did he sell Hortonworks to Cloudera in January 2019, he also sold Docker's enterprise business to Mirantis — each within the past two years. And now, as Cloudera’s CEO, Bearden could be looking for the next strategic deal. And without question, activist investor Carl Icahn, who owns an 18.4% stake in Cloudera, along with two board seats, would be in favor of deal.

The question is now, who would buy Cloudera?

There has been tons of speculation. Rishi Jaluria, analyst at D.A. Davidson, has listed both IBM and Microsoft (MSFT) as potential suitors, along with the obligatory mention of private-equity firms. Chad Bennett, analyst at Craig-Hallum, back in April threw his hat into the ring, asserting that IBM would be a logical buyer for Cloudera. To be sure, these are all rumors and, at best, just analysts attempting to connect the dots. But also, where there’s smoke, there’s often a fire.

For starters, following Hortonworks' integration, Cloudera has now produced three consecutive quarters of business stabilization. First-quarter EPS came in at 5 cents per share, easily beating the penny per share analyst were looking for. Revenues grew to $210.46 million, rising 12.3% year over year and ahead of the consensus estimates of $204.65 million. Annualized recurring revenue rose 11% to $723.4 million at quarter's end.

What’s more, not only did Q1 gross profit advance 24% to $156.2 million, Cloudera narrowed its GAAP net loss to $58 million, down from a year-ago loss of $103 million. To top it off, the company ended the quarter with roughly $520 million in cash on the balance sheet. Relative to other recent reports, Cloudera’s Q1 numbers weren’t breathtaking, but they were impressive considering the pandemic backdrop.

All told, the company handily beat Q1 and updated Q2 and FY 2021 EPS above consensus estimates. The selloff ensued as the company lowered revenue guidance. And I think the recent decline in CLDR stock makes the M&A deal more attractive. I think the fundamental story in CLDR stock is undervalued, particularly on the heels of the company’s solid earnings results, showing not only upbeat subscription revenue, but more importantly, rising operating margins.

From a complementary and growth standpoint, Cloudera fits all the criteria IBM should be looking for in an M&A candidate. And Cloudera can provide IBM — which now owns Red Hat — an immediate leadership position in the Hadoop/Spark ecosystem. What’s more, since the introduction of its CDP Public Cloud, Cloudera is seeing less churn and stronger subscription renewal rates.

Can IBM afford Cloudera?

With $12 billion in cash and marketable short-term investments and long-term marketable securities, IBM can buy Cloudera four times. Not to mention, IBM can raise billions more in cash at cheap interest rates, arming the company with tons of financial firepower to seal a deal. How much would it cost?

Both Cloudera CEO Bearden and Carl Icahn would listen to any deal that offers a 40% premium or higher. And while Cloudera's stock price is at around $11, the base price for a deal would probably start at the mid-range of its 52-week high price, which is $12.50 per share. Add a 32% to 35% premium to $12.50 and Cloudera can be bought right now for $16.50 to $17 per share or around $5 billion.

Bottom Line

To be sure, a deal for Cloudera would come with some risks, namely because IBM is still in the process of integrating its deal for Red Hat which it acquired last July. What's more, while Cloudera's big-data crunching capabilities has shown it can scale profitably, it's still not real clear whether it can take the punch from market leaders like Amazon (AMZN) and Microsoft. That said, I think a union between IBM and Cloudera, particularly given the latter's dependence on open-source software, could enable them to do what they've been unable to do separately. As such, I would be buying both stocks.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CLDR over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.