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International Business Machines Corp. (NYSE:IBM) announced that it has entered into an agreement to acquire SoftLayer, a public cloud infrastructure provider for SMBs, for an undisclosed sum. However, based on analysts estimate of ~$400M of revenues, 50% EBITDA margins, and a 10x EBITDA or 5x FTM Sales multiple, RBC Capital believe the transaction could be valued near $2B. The transaction should close in Q3:13, and International Business Machines Corp. (NYSE:IBM) will report the business along with existing cloud revenue in a new division, Cloud Services, in order to improve the transparency of its growing cloud portfolio. In RBC’s view, the acquisition of SoftLayer should augment IBM’s existing SmartCloud portfolio by accelerating the build of public cloud infrastructure to a global scale, particularly to the large enterprise market. Analysts at the firm also believe it should improve the firm’s competitive position against public cloud rivals such as AWS and Rackspace.

SoftLayer was formed in 2005, provides IaaS solutions based on different cloud architectures to 21,000 customers such as Web startups and global enterprises. It is headquartered in Dallas, TX and boasts nearly 100,000 servers under management spanning 13 data centers across the globe.

With the acquisition expected to close in Q3:13, analysts believe it will be more beneficial to FY14 revenues and profitability. The new Cloud Services segment will report to Erich Clementi, SVP Global Technology Services. International Business Machines Corp. (NYSE:IBM)’s current cloud business grew 80% y/y in 2012, and they believe the acquisition should enable IBM to achieve its goal of $7B in cloud revenue by FY15 by building out its cloud client base (was 9,000 prior to acquisition) and accelerate IBM’s ability to provide solutions for all cloud environments (e.g., public, private, hybrid). RBC Capital maintain its estimates and expect to receive clarity on the financial impact during the June-qtr call.

Continuous Growth: While International Business Machines Corp. (NYSE:IBM) has set the standard for a large-cap enterprise IT business model, analysts at RBC believe the company will keep its focus on acquiring additional recurring revenue streams in the future. With this in mind, analysts says that they would not be surprised to see it acquire small cap or private companies that operate in cloud services, security, virtualization, flash, or big data analytics. Analysts note IBM did acquire Kenexa (SaaS) and Texas Memory Systems (flash solutions) recently.

IBM’s Target Price:

Analysts at RBC think revenues will remain flat y/y in FY13, while operating margins advance 120bps to 22.0%. They anticipate ~3–4% growth in global IT spending, which is a modest improvement from 2% growth witnessed in FY12. Given International Business Machines Corp. (NYSE:IBM)’s healthy services backlog, large annuity revenue streams (60%+ of profitability), enterprise productivity initiatives, and strong free cash flow generation capabilities allocated toward share buybacks, analysta at the firm believe IBM should generate solid EPS momentum in FY13. Based on ~12x FTM EPS, the stock could achieve firm’s price target of $200.