In a significant strategic shift, International Business Machines (IBM) has spent the past decade realigning itself for the era of cloud computing and artificial intelligence (AI). This transformation was catalyzed by the company’s acquisition of SoftLayer for $2 billion in 2013, which jumpstarted IBM’s presence in the cloud business. Subsequently, in 2019, IBM made a substantial bet on multi-cloud and hybrid cloud deployments with its $34 billion acquisition of Red Hat.
To streamline its operations and focus on core strengths, IBM has also divested underperforming businesses. This included unloading its semiconductor manufacturing operation and x86 server operations in 2014, spinning off its managed infrastructure services business in 2021, and discontinuing its Watson Health business in 2022. This strategic realignment has made IBM leaner and more focused than it was a decade ago.
While IBM’s stock performance has faced challenges, analyst Matthew Swanson of RBC Capital recently initiated coverage of IBM with an “outperform” rating and set a $188 price target. This target represents a potential upside of nearly 30% from the current stock price, which demonstrates optimism in IBM’s valuation and growth prospects.
IBM’s revenue is predominantly derived from two segments: software and consulting. In the second quarter, the software business generated $6.6 billion in revenue, growing by 8% at constant currency, while the consulting business brought in $5 billion, with a growth rate of 6%. These segments jointly contribute to about three-quarters of IBM’s total revenue.
Swanson contends that investors may not fully appreciate the potential of these segments, especially as IT environments become increasingly complex. Large organizations with sprawling IT infrastructures require modernization that goes beyond a one-size-fits-all approach, necessitating software solutions and expert guidance. IBM’s software business addresses the former, while its consulting arm handles the latter.
Moreover, IBM’s consulting services are not limited to IBM’s own solutions. The company maintains partnerships with major cloud providers like Amazon Web Services, Oracle, and SAP, enabling it to recommend and integrate non-IBM solutions when beneficial for clients.
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IBM is poised to benefit from the growing complexity of IT environments. In addition to assisting clients with hybrid cloud deployments, the company aims to become a preferred partner for enterprise AI. IBM’s Watson platform empowers clients to develop and implement AI models while addressing issues of transparency, privacy, and regulatory compliance.
IBM’s growth outlook remains solid, with an expected revenue increase of 3% to 5% this year when adjusting for currency effects. With a strong focus on hybrid cloud and AI in its software and consulting segments, IBM is well-positioned for long-term growth.
The company’s free cash flow is projected to reach approximately $10.5 billion this year, maintaining a price-to-free-cash-flow ratio of under 13. The high-margin software business is expected to contribute to improving profit margins over time, facilitating further growth in free cash flow.
Investors also benefit from IBM’s sustainable dividend, yielding about 4.5%. While dividend payments are expected to total just over $6 billion in the coming year, the company’s financial position allows for ample resources for acquisitions and debt reduction. Although IBM temporarily halted share buybacks to address debt from the Red Hat acquisition, they could be resumed in the future.
Despite ongoing challenges, IBM’s strategic shift towards cloud computing and AI positions the company for growth. Analysts’ optimism, coupled with a focus on software and consulting in complex IT environments, suggests that IBM may be on the path to brighter days and potential stock price gains in the near future. While the company’s transformation is a work in progress, its presence in the cloud computing and AI markets signifies a promising future.
