International Business Machines (IBM -1.88%) fell well short of revenue expectations when it reported its first-quarter results, prompting the stock to tumble. The culprit behind the disappointing numbers was a delay in signing a few major deals. A few services deals that were originally expected to close during the first quarter got pushed back, hurting the company's results.
At least one of those deals has now closed. IBM announced on June 8 that it had signed a 10-year cloud services agreement with Lloyds Banking Group (LYG -0.70%) in the United Kingdom, a financial institution with over $1 trillion of assets. IBM will provide dedicated cloud offerings hosted in both Lloyds and IBM data centers, and it will manage the application migration process to the new cloud. The total value of the deal is about $1.65 billion.
This news comes soon after reports emerged that IBM lost a major public cloud customer. Facebook is moving its WhatsApp service from IBM's cloud to its own data centers. WhatsApp uses 7,000 high-performance bare-metal servers provided by IBM's SoftLayer infrastructure-as-a-service business, and Facebook reportedly spent as much as $2 million each month with IBM.
The Lloyds deal dwarfs the WhatsApp loss, and as I argued in a previous article, the social titan would have moved WhatsApp to its own data centers regardless of what cloud it was running on. The public cloud is a part of IBM's cloud strategy, but deals like the agreement with Lloyds are the core.
How IBM will grow its cloud business
The Lloyds deal is exactly the kind of deal IBM is well positioned to win. Lloyds is a large enterprise, with a market cap of $64 billion and annual revenue of around $50 billion. It's an existing IBM customer, with the two companies having a long-standing relationship. And it's looking to embrace cloud computing.
Transitioning to the cloud is not trivial, especially for a large enterprise, and doubly so for one in a highly regulated industry like banking. While the ongoing shift to cloud computing has forced IBM to adapt, signing deals with less hardware and more cloud services, the need for such deals hasn't diminished. As IBM CFO Martin Schroeter said during a recent earnings conference call, IBM is shifting from being a systems integrator to a services integrator. The Lloyds deal is a reflection of that shift.
One important thing about this deal, especially for those worried that lucrative hardware deals are being replaced with lower-value cloud deals, is that this agreement represents a new revenue stream for IBM. It's an expansion of the relationship, with IBM set to play a greater role.
Large organizations comprise IBM's core customer base. As those organizations begin thinking about shifting to the cloud, IBM is the logical choice to manage that transition. The value of IBM's existing customer relationships should not be underestimated. Hot start-ups may be unlikely to choose IBM's public cloud offerings over AWS or Azure, but IBM has an advantage when it comes to large organizations with complex IT infrastructures.
IBM's cloud business generated $14.6 billion of revenue over the past year, with cloud delivered as-a-service currently at an $8.6 billion annual revenue run rate. The latter number grew by 59% year over year during the first quarter. The Lloyds deal, and other similar deals in the future, will help keep the cloud business growing.
When this cloud growth, and growth in IBM's other "strategic imperatives," will ultimately drive revenue growth for the company as a whole is still unclear. Parts of IBM are growing quickly, but other parts are shrinking, and the net result has been five years of declining revenue. IBM expects per-share adjusted earnings to grow this year, but a return to revenue growth has yet to materialize.