What the IBM-Red Hat Deal Means for Cloud Computing Stocks

After a blistering start to the year, cloud computing stocks have been hit hard during the recent market correction, tumbling 11.3% in October. But the sector may have been thrown a life raft on Sunday in the form of the IBM-Red Hat deal.

In case you missed it, here was the deal: International Business Machines (IBM) has agreed to acquire Red Hat (RHT), a cloud-computing giant, for $34 billion. The IBM-Red Hat megadeal is expected to close in the second half of 2019, pending approval from shareholders and regulators. So far, Red Hat shareholders are loving the deal.

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Red Hat stock was up more than 47% in early Monday trading, gapping up from 116 to around 170 in the blink of an eye (see chart below).

Red Hat took off after the IBM buyout. Can other cloud computing stocks do the same?IBM is paying $190 per share of Red Hat stock, which means RHT could have even more room to run yet before the deal is finalized late next year. Needless to say, however, if you didn’t own shares of RHT prior to the IBM takeover, chances are you missed out on your big payday. (And if you did own shares of Red Hat, you must have read Crista Huff’s story in this space last week about the benefits of owning takeover targets.)

Meanwhile, IBM shares were actually down slightly in early Monday trading, which tells you their shareholders weren’t too jazzed about the Red Hat deal—or at least the high price the company paid in the acquisition. Perhaps they’ll change their minds in the coming days and weeks, especially with IBM stock at new 52-week lows.

The bigger-picture takeaway is what the IBM-Red Hat deal means for cloud computing stocks as a group. So far, the bump has been somewhat modest—the iShares North American Tech-Software ETF (IGV), which holds 55 software and cloud computing stocks, got a 1.8% Monday bump as of this writing, ahead of the 1% jump in the S&P 500, but not crushing it. The index is still below its 50- and 200-moving averages, though it’s now within spitting distance of the latter at least.

Of course, prior to October, cloud computing stocks were among the best-performing sectors on the market, jumping more than 30% through the first nine months of 2018. But the sector was grossly overvalued, and a comeuppance was inevitable, according to our Tyler Laundon, whose Cabot Small-Cap Confidential advisory has had a huge year thanks in part to several cloud computing stocks in his portfolio.

Now values are more in check after the recent selloff. And should the market break out of its October funk and resume its previous uptrend, cloud computing stocks could look like much better buying opportunities than they did a month ago. What the Red Hat buyout does is at least call attention to the stocks, and give the sector some sorely needed good news.

As always, we’ll let the charts tell us which way the winds are blowing. And right now, cloud computing stocks still look a bit shaky. But Monday’s post-buyout action was a step in the right direction, if not a full leap.

Chris Preston

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Investment analyst and Chief Analyst of Cabot Wealth Daily, Chris Preston brings you all the latest from the investing world. Sign up to get updates and breaking news delivered FREE to your inbox. Get unlimited access to our library of complimentary investing reports.

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