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International Business Machines Corporation's Biggest Win in 2016 So Far

By Tim Brugger – Sep 20, 2016 at 8:11AM

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It’s been a solid, if not spectacular, year for Big Blue, largely because it’s delivering on this key metric.

Until recently, IBM (IBM 0.41%) shareholders were forced to be content with its stellar 3.6% dividend yield, because its stock was meandering, and it didn't appear as though it would ever gain traction. Though its performance in 2016 may not top the charts, IBM's 17% share price gain year to date is nothing to sneeze at.

It's how IBM is generating positive momentum this year that should give shareholders reason for optimism. CEO Ginni Rometty has asked for patience as IBM undergoes one of the biggest -- and most critical -- transformations in the storied history of the industry stalwart. And that patience is being rewarded thanks to IBM's biggest win in 2016.

Image source: IBM.

Ahead of schedule

It wasn't long after Rometty took the reins in 2012 that she introduced investors to IBM's new focus: It's aptly named "strategic imperatives." Even before Rometty took the top job, as VP of IBM's global business services, she introduced new opportunities including the cloud, analytics, and big data, which were cutting edge at the time and just beginning to go mainstream.

IBM has added the Internet of Things (IoT), cognitive computing, and data security as strategic components of its transformation plans. The target has long been to derive 40% of IBM's total revenues from the upstart technologies by 2018 -- no easy feat given it generated $81.7 billion in sales in 2015.

By the end of last year, strategic imperatives accounted for 35% of revenue, led by a whopping 57% year-over-year improvement in cloud sales to $10.2 billion. It's what IBM has done for an encore in 2016 that warrants its biggest win: It's ahead of its own aggressive strategic imperatives schedule and is challenging Microsoft (MSFT -0.29%) and virtually every other cloud provider for the king of the hill.

Just two quarters after posting strong end-of-the-year results from its strategic imperatives units, IBM finished 2016's Q2 by generating $8.3 billion of its $20.2 billion in total revenue from its most important growth drivers. Last quarter's annual run rate of $30.7 billion for IBM's combined strategic divisions now accounts for 38% of sales.

Third-quarter results are scheduled for Oct. 17, and with the momentum IBM is gaining in its transformation, Rometty's strategic imperatives goal of reaching 40% of total revenue could be surpassed a full year early.

How'd they do that?

Like Microsoft, IBM's skyrocketing strategic imperative sales are thanks to its emphasis on data analytics, services, and security delivered through its cloud and associated solutions. Sure, IBM has its SoftLayer cloud platform, and Microsoft has Azure, but those are just means to an end. Microsoft hasn't reached more than a $12.1 billion annual cloud revenue run rate by merely hosting data in Azure.

Microsoft has reached its leadership position by delivering its suite of software-as-a-service (SaaS) products, including Office 365 and Dynamics CRM, via the cloud. IBM's $11.6 billion annual cloud revenue run-rate has soared for similar reasons -- and there's a lot more to be had. One estimate suggests the cloud services market will climb to $256 billion in two years.

IBM"s strength in cognitive computing, data analytics, and associated solutions is what drove its 50% jump in cloud-as-a-service revenue of $6.7 billion last quarter.

Though delivering on its strategic imperatives warrants IBM's biggest win so far in 2016, it's worth noting that Rometty's expense management efforts are also making strides. If not for $1.95 billion in capital expenditures so far in 2016, IBM would have enjoyed a nice bump in free cash flow.

IBM has also spent $5.4 billion on acquisitions in 2016, which, not surprisingly, negatively impacted margins and overhead. That said, virtually every one of IBM's 11 deals in 2016 were strategic imperative-related, which will give its already-positive momentum a boost.

As it stands, IBM has yet to win over the Street based on its so-so price target of just $160 a share and "hold" rating. But with its industry-leading dividend, forward price-earnings-ratio (P/E) under 11, and strategic imperatives gains, IBM is not only winning where it counts, it's still a great value.

Tim Brugger has no position in any stocks mentioned. The Motley Fool owns shares of Microsoft. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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