Orlando Bravo and IBM CEO Arvind Krishna on AI, the Future of Software, and IBM’s $34B Red Hat Deal

I think AI is great.

Thank you. This is not scripted.

I'm doing good. So, these are all your investors.

Week's been a good week. Let me think. This morning was different investors here in the city. Friday I was at Illinois at the Grainger College of Engineering. I was also in DC, headed back there early in the morning.

Between DC, between clients. My ordering is very clear: clients first, then employees, then all of the external forces, whether it's government or investors, and then that gives us an outcome that we can serve our communities with.

I say I always have an opinion. May not always be right.

Random oscillating path, but I call it, look, my path is not a common one. Very rarely do people start off in the bowels of the research organization by choice and decide that they want to get to be much more in the business than just there and then sort of proceed down that path. So that's why it's not common. On the other hand, I would say I think 90% of the world is blind to opportunity. With respect, that probably includes some of you. You kind of have blinders on because you kind of don't think about everything that could be possible. And I've always believed, you know, keep your eyes open. There's opportunity. So, I'll talk to anybody actually inside the company or outside. I have my own filter. So, I may not follow 99% of what is there. But listen, because you can't predict what is that 1% that has incredible opportunity tied up in it. What is it? 99% perspiration, 1% inspiration is a piece of it.

I grew up in India. I spent my first 21 years in India and I would call it almost idyllic. I was a good student, not a great student until I got to college. College was a little competitive. So if your competitive spark kicks in, then you go compete. And that is when I learned also. I went to a really tiny high school. I went to a high school with 11 kids, my graduating class, of which only four graduated. Seven did not actually complete enough credits to graduate. So that tells you what the school was like. I was a good test taker. So I got into probably one of the most competitive colleges in India. So then you get in and you meet all these other kids. They are all from the big city. They kind of knew everything. They kind of knew what the faculty were talking about and I had no idea what the hell they were talking about. So you kind of say okay like I got to like work at this otherwise I'm going to sink. And then you discover after two or three months that if you are willing to put some work in, not insane amounts, just a decent amount of work, all these people who are very smart, they might have been smart but they were not actually flourishing as much. And that taught me that you don't always have to depend upon what you knew coming in. If you're willing to learn, read, listen, you can do pretty damn well. And that probably helped me throughout including then my decision to come to the United States. Remember 1985 was like way pre-internet. You were reading brochures and manuals and kind of decide where to go. So I said if I can get into a top five engineering school for a graduate program, I'll do it. That was really the criteria. And why Illinois? It looked a lot like where I went to my undergraduate. Okay, that was wheat. This was corn. But it was in the middle of an agricultural area. That was kind of a weird idea, but it was a top five school, so that helped.

35 years this coming December.

It's a bit of both. When I went in, IBM at least in the R&D spaces was incredibly competitive. They didn't say it publicly otherwise they might have scared off too many people. But when I went in, you were in your second year going to present what you had done over two years, not just to your upline manager, but to all their peers. And it was a pretty public rating. After 30 minutes, they would come out and tell you what they thought of your work. And I remember like it was going to fall into three buckets. You know, we're not going to fire you, but you're probably never going to get a raise again in your life. So, you should decide what you want to do. And probably 20 to 30% fell into that bucket. Then 50-60% fell into the bucket of you're doing good work, we encourage you, but you're not kind of a star, or you fall into the third bucket. And so it was competitive, but I felt that that was how it should be because you can sort of have a sense of where you are. And I went from there about 6, 7, 8 years and there was a mentor who really pushed me to think about what's possible, what can you do. That got me out from research to think about going into the business. And he took a big risk. He took this guy who had only done research, who had only done technology, never run a business, no P&L, and said here is cyber security, we have no idea what we want to do with it, why don't you figure out a strategy. And by the way, if you want to buy some things, I'm willing to spend some money. We bought Dascom, which did policy management. We bought Access 360. I divested our PKI business. I'm so glad nobody's made money on public key infrastructure yet. I think...

And I think you make my point.

And very competitive as we can see. And that was one big moment. Then another five years after that somebody said we'd like you to write the business strategy for software. And I said I'm a technologist, I've run a business, I mean like I don't know this stuff. But it was a great experience because you kind of learn of taking a long-term view and putting some math behind some, I'll call it, macro trends really. And in 2013, somebody looked at me and said, 'We want you to run all of hardware manufacturing.' I'm a software guy. I don't know anything about semiconductors and those things. But you know, the serendipity and keep your eyes open. I never took more than like 10 minutes to say, 'Okay, that's what you want me to do. I'll go do it.' It was not like, 'Okay, I need to think for a week.' But I think all those collective experiences probably prepared me to be a good candidate for the role I'm in because that gave me the depth, you said operations, that gave me a really good sense of how the different parts of the company functioned, how things really get decisioned, not the decision at the top in a boardroom but like kind of what's it impact, who does what. And that breadth I think has really served me really well in my current role.

Yep.

So if I go back to 2016, 17, I was running our cloud business. I came to the conclusion, and we were nowhere compared to what are now called the hyperscalers. They weren't quite called the hyperscalers, they were just called public cloud at the time. So you have two choices. It's too big a business to ignore. You can't just say you know I'm going to put my head in the sand and just forget that it exists. I mean like that doesn't work if it's that big a trend. So you get two choices. Are you going to compete with them, which is what everyone wanted to do, or do you find a way to be a partner and to ride their success? And I said because IBM had bought a company called SoftLayer for a couple of billion, the thought was we're going to go compete. I kind of came in my head to the conclusion you can't compete. So I was very direct: you can spend 10 billion a year and I said five years from now we'll still be five years behind. So that doesn't seem like a great place. Second, I said best case, I can see ourselves being fourth or fifth because I don't see any way in which you can catch up to Amazon, Microsoft, Google at the time. And I actually said fifth because I thought Oracle would actually go in even though this was well before they were that big in there. That was actually my conclusion. So I said, if you want to ride them, what are the characteristics of what one has to do? It has to be on a piece of software that everybody wants to use and it will ride both in public and private. Now part of that bet was that 50% of the workloads could be 40, could be 60, doesn't matter. I'll call it 50 for argument's sake, are not actually going to migrate to the public cloud. If that's the case people need something that can straddle both. So then you say what is the most likely thing that can straddle both and it has to be open otherwise people are going to be afraid of proprietary lock-in. So that is why one and not the other one which was even bigger. So that is why Red Hat. And so I said now the secret thing inside Red Hat was something called OpenShift which is a container platform, tiny, 110 million, not that imprecise when we bought the company. And I said I think this will be a multi-billion dollar software platform as big as the Linux business. So the Linux business would give you the credibility, it'll be the way to go back and forth. And if we can get a platform going on which people can do development both private and public, then that'll be a great platform and we'll be number one on private if we succeed. There were three competitors at the time. By the way, when we bought it Orlando, our stock fell 20% the day it got announced. So, and I remember all the headlines. You guys have overpaid. Don't know what are you doing, what is this thing, I mean like what does IBM understand about open source etc etc. It really told me that people are really shallow because people felt that the growth rate would stall and it would fail inside IBM. So that is why the stock fell. Well, we've doubled the revenue, we have increased the margins. OpenShift which was 110 million is over a billion five. Ansible which was no revenue to talk about is probably half a billion plus. So not a bad software business to double the revenue of it and the growth rate increased after we bought it.

Yeah. So it helped that it was a good cash flow business. Look, most of you know this in the software business. If you have a good ARR business and your NRR is over 100%, which it should be if you have a good product and a set of products and good execution, you need both those things. Then your cash flow is actually quite a bit ahead of profit because you're collecting cash ahead of delivering the revenue. So it was running at not quite a billion but close to a billion of cash flow on about 3.4 billion of revenue at the time. So we said we are going to preserve that but we should be able to take some cost out because you don't need investor relations, you don't need public treasury, you don't need all those functions. So there is some cost that can come out and we should be able to improve this margin over time. It will take a year or two to get in there. I was pretty convinced. I had committed 12% revenue growth to the board when we bought it. We actually for the first five years did I think 14 if I remember. So when you combine those two then actually the return is incredible because I would turn around and look at you and say at 7.5 billion of software growing in double digits with margins approaching 30%, my gut is this would be on itself worth about 70, which means you've doubled our investor's money.

Yeah, we'll talk about that. But I first make a joke. A couple of times you and I had discussions about some potential deals.

But the decision you made a lot of money on that deal.

But if you think about the decisions really at the end of the day, was it deeper than a conversation between the two of us? So at the end of the day you always have to come down to do we want rigor in the financial model that it does meet all our digs. Yes. So but on Red Hat to be honest because I was not in my current chair. I was running our software business at the time. It was a year-long process to convince everybody to take the risk. Partly one, people didn't see the vision of what OpenShift could be. So then the answer was okay you're buying a mature product called Linux, like how fast can you grow it? Because if we step back it should grow at the server rate which is like 3, 4, 5, 6%. Like that doesn't seem that attractive. And I said well yeah but you're also taking three points a share each year from Windows. So it's not just the server rate you're doing that. And by the way if you add capability I think you can get that up to the high single digits but the bet is really on the container platform. That was not an easy thing to convince because you needed to have two bold assumptions. One, the world is not all going to a singular public cloud and in 2016 and 17 that was the conventional wisdom and I said this is never going to happen. Like I just don't see enterprise clients and people outside the US being dumb enough to get locked in to one public cloud. I just don't see it. But you have to convince people of that point of view. And then the second was if that's the case then you need something that can straddle that environment for people and hence the container platform because without that you just use whatever is on a one cloud and that's enough of an answer. So what was happening around sovereignty, maybe I got lucky that all of geopolitics pointed that to people. I always felt like you can't depend upon a cloud for everything because there are these little things called cables that go under the ocean and it's not very hard to cut them if you get upset with somebody. And so you had to first convince that there was a strategy and that that could go there. Next then you have to have a financial model that you could lay out and that took but the guy who's now our CFO very much got on board that this is possible and once he got convinced that we could grow it a bit faster and you look at that cash return and you could say well then the one will become two if you're getting two a year then the deal is absolutely worth it right there and then. And so all those things combined helped make the decision and fast forward, but here's where we are.

This was about five times the size. And I remember also because we were working together on something else that when you did the Red Hat deal and you were looking at the thing with us, it was a tough time in the market. The market had crashed there in that quarter.

Well, there were two reactions. One, because the Red Hat deal was announced and I don't think we've ever reneged on a deal after it was announced. So, but the reaction was clear. The board reaction was, is this a moment because the stock had fallen 20 bucks that an activist is going to walk in try to decimate management and the board. So, the reaction was honestly in hindsight was we can't do anything else that will attract attention. So, everything else is off the table for the next 24 months. And that was October of 2018. We had also done a second thing at the same time. So the which was a big cause for the reaction I don't know the other thing was that we also had done, we had divested all of our semiconductor manufacturing. That's a few years before and those things were all people were beginning to understand what the implications of all those things were and so those combination got everybody to we're going on a pause until you digest this and can prove that you can run it.