The Ratings Game: Software stocks jump as analysts bet ‘surge of cloud M&A’ could follow IBM/Red Hat

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Software stocks soared Monday, after International Business Machines Corp. said it planned to acquire Red Hat Inc. in a deal with an enterprise value of roughly $34 billion, at a hefty premium.

Shares of Pivotal Software Inc. PVTL, +5.77% Splunk Inc. SPLK, +3.55% , and Workday Inc. WDAY, +1.74%  were among the biggest gainers during Monday’s regular session, with Pivotal up nearly 6%, Splunk up 1.7% and Workday up about 4%. Shares of Nutanix Inc. NTNX, +3.12% , Dropbox Inc. DBX, +1.38% and Zscaler Inc. ZS, +1.24%  also traded higher Monday.

IBM’s IBM, -4.13%  planned acquisition of Red Hat RHT, +45.38% which uses Linux to build and manage systems, comes in the wake of several other recent high-profile software deals. Salesforce.com Inc. CRM, -3.34% completed its $6.5 billion acquisition of MuleSoft back in May, while Microsoft Corp. MSFT, -2.91% announced last week that its $7.5 billion deal for GitHub had closed. Meanwhile, Hortonworks Inc. HDP, -2.00%  and Cloudera Inc. CLDR, -1.83%  said in early October that they planned to combine in a $5.2 billion merger.

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Some analysts believe that Red Hat was the subject of takeover interest from more than just IBM — Bernstein’s Toni Sacconaghi said Cisco Systems Inc. CSCO, -0.93%  was a possibility — helping to explain the large 63% deal premium.

And while there’s debate over whether a competing bid might emerge, many seem to think more deals could follow, fueling excitement in the sector on Monday.

IBM’s bid for Red Hat and Hortonworks’ proposed combination with Cloudera represent just the “tip of the iceberg of a major cloud consolidation period,” wrote Wedbush analyst Daniel Ives. He sees “a surge of cloud M&A set to take hold as both strategic and financial acquirers aggressively go after cloud deals in 2019” and deems Pivotal, Qualys Inc. QLYS, -1.14% and Zscaler his top targets.

Raymond James analyst Michael Turits also sees the potential for more cloud deals going forward.

“Especially post the recent pull back on in tech valuations, this deal could spark consolidation of other large cap, category leading, ‘at scale’ vendors including Splunk, ServiceNow Inc. NOW, -1.52% , Atlassian Corp. TEAM, +0.01% , Workday, and Tableau Inc. DATA, -0.22%  , as well as a host of smaller cap vendors — especially with large technology vendors anxious to compete with the public cloud portfolios of [Microsoft Corp.’s] Azure and [Amazon.com Inc.’s] AWS,” he wrote.

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J.P. Morgan’s Sterling Auty named a number of other potential candidates. Okta Inc. OKTA, +1.04%  and DocuSign Inc. DOCU, -2.02%  could be strategic takeovers given that they have unique solutions. Okta “offers best in class cloud identity solutions that are very important to the shift of applications to the cloud,” he wrote, while DocuSign is the category leader in the market for electronic signatures. As the company continues to migrate physical contracts to digital formats, DocuSign might be attractive to another tech company, or a financial services player, he reasons. Read more about potential cloud M&A.

Veeva Systems Inc. VEEV, +0.32%  and Medidata Solutions Inc. MDSO, -2.05%   both have strong “vertical industry exposure” that could prove beneficial to life-sciences companies, Auty said, while Akamai Technologies Inc. AKAM, +0.13%  and LogMeIn Inc. LOGM, -0.23%  are among beaten-down names that sport attractive valuations.

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The First Trust Cloud Computing ETF SKYY, -0.34%  fell 0.3% in Monday trading, and has gained 14% over the past 12 months. The S&P 500 SPX, -0.66%  has gained 2.3% in that time.