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Why IBM's Ready to Regain Growth

By Herve Blandin – Updated Sep 23, 2019 at 11:32AM

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This seemingly stodgy company is quietly pursuing promising new technologies with big potential.

Tech giant International Business Machines (IBM 2.27%) doesn't seem like an agile, innovative company primed to outperform the fast-moving tech industry. IBM's large scale and long history magnify the market's doubts about the company's ability to become a growth story. But Wall Street doesn't realize yet just how much IBM is actually poised to drive technological shifts – and its own future expansion.

Shift to the cloud 

There are many reasons to view IBM as a shrinking old-tech company. After several years of decline, trailing-12-month revenue dropped to $79.6 billion, compared to a peak of $106.9 billion in 2011. The 108-year-old company has been struggling with hardware-related businesses and has divested some of these legacy activities. For instance, the Intel-based server business IBM sold to Lenovo in 2014 represented $4.6 billion of revenue the previous year. Employee headcount shrank from an average 433,362 in 2011 to 350,600 in 2018, another sign of decline.

But IBM is transitioning to growth areas, and the shift to cloud computing is a significant part of this strategy. IBM's trailing-12-month cloud revenue of $19.5 billion grew 8% year over year. And the acquisition of Red Hat should contribute to the expansion of its cloud businesses, which represented roughly 25% of IBM's revenue over the last 12 months. This evolution has also fattened margins: Pre-tax income margin increased to 16.6% during the last quarter compared to 15.9% two years ago.

As a result, management forecasted mid-single-digit revenue growth over the next couple of years. And given IBM's operating leverage, operating income is expected to grow at a faster pace.

Cloud computing

Image source: Getty Images.

IBM's potential to become a disruptive high-tech company

IBM's capacity to adapt and keep up with the evolution of technologies goes beyond its cloud-based initiatives, though.

For many years, the company has been holding the top position in the list of the number of granted U.S. patents. In 2018, IBM filed more patents (9,100) than the next two companies combined (5,850 and 3,056). Besides, IBM processors equip the two most powerful computers in the world, according to top500.org, and a third IBM supercomputer made it to the top 10.

These technological achievements don't translate into immediate earnings. But they show IBM's capacity to innovate and propose performance solutions. And the company's pursuing other promising forays into disruptive technology.

For instance, over the last few years, IBM launched several initiatives around blockchain technology such as its food safety blockchain and its payment system. The Food & Drug Administration recently selected IBM to develop a blockchain-based pilot program for real-time monitoring of drug supply chains. And IBM has already developed worldwide and commercial blockchain applications, such as its co-project with Maersk, TradeLens. Many companies are developing blockchain technologies, but none of them has reached IBM's worldwide scale and commercial status.

In addition, the quantum computing technology IBM is developing doesn't get as much attention as Alphabet's moonshot projects about self-driving cars and delivery drones. But investors should also consider that technology's potentially huge leap in computational power.

The market ignores IBM's growth potential

Despite IBM shares' roughly 25% increase since the beginning of the year, the company's modest trailing-12-month P/E ratio around 15 indicates the market doesn't expect any growth.

But investors should look beyond the weak results IBM reported over the last several years. Growth from the company's cloud businesses will become obvious during the next couple of years. And IBM's investments in disruptive technologies like blockchain and quantum computing constitute additional long-term opportunities. 

Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Herve Blandin owns shares of IBM. The Motley Fool owns shares of and recommends Facebook. The Motley Fool is short shares of IBM and has the following options: short January 2020 $200 puts on IBM and long January 2020 $200 calls on IBM. The Motley Fool has a disclosure policy.

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