CNBC's Jim Cramer on Thursday broke down why IBM's $34 billion price tag to buy Red Hat was worth the cost.
Paying $190 a share for the open-source software, the October deal came at a 63% premium in part. Cramer argued that premium is understandable because IBM was not the only bidder. In late 2018, Red Hat revealed that there were three other bidders without naming names. CNBC previously reported an offer from Alphabet's Google was entertained, and Stifel analyst Brad Reback also said that Google, Amazon and Microsoft engaged in discussions.
"It was a competitive situation, people, so IBM paid what they had to pay to get the job done," the "Mad Money" host said. "But, honestly, that 63% number it's a little misleading, frankly."
The premium isn't quite as hefty when compared to Red Hat's average share price last year, Cramer said. At the time the agreement was announced, Red Hat traded at $116 per share. The stock, on averaged, sold for under $142 a share in 2018, which instead comes in at a 34% premium, he said. The deal closed earlier this month.
Since the deal was announced in October, the rest of Cramer's "cloud king" basket of hot cloud-based tech stocks, which once included Red Hat, have increased market cap as a group by 54%. They also trade, on average, for 54-times next year's earnings, the host said. IBM, however, paid 46-times for Red Hat, he noted.
"If anything, I've got to tell you, based on these comparisons, you could argue that they underpaid for this company," Cramer said. "In other words, I don't think they overpaid versus what this business was really worth."
Big Blue, which made a name for itself selling computer hardware, pivoted into the cloud-based software business as a way to boost revenue growth, he said. Artificial intelligence and analytics is also a part of the focus. The company wants to offer a platform to manage hybrid cloud IT infrastructure, and Red Hat is a solution, he said. Red Hat, which will keep its identity and leadership as a subsidiary, lets IBM combine on-site private servers with third-party cloud computing.
IBM has been working to catch up to Amazon and Microsoft in cloud infrastructure. At the time of the acquisition, CEO Ginni Rometty called it a "fair price" to become the "number one hybrid cloud provider."
Red Hat is critical, Cramer said, seeing that IBM reported a second quarter earnings beat but cloud sales were up 9%, down from 16% the quarter prior and 18% in 2018. Revenue came in line with Wall Street's expectations, although it fell 4% year-over-year.
Red Hat was not included in the numbers.
"I think these results more than vindicate IBM's decision to pay $34 billion" for the company, he said. "They needed a change of direction and that's what Red Hat gives them. It's why I still think the stock is still worth owning here even up here after this nice day."
Disclosure: Cramer's charitable trust owns shares of Alphabet, Amazon and Alphabet.