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4 Ways the Coronavirus Pandemic Could Impact IBM

By Herve Blandin - Mar 28, 2020 at 10:00AM

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The tech giant is facing the coronavirus situation just after it increased its debt load in a significant way to finalize its largest acquisition ever.

The coronavirus outbreak represents a serious threat for industries such as restaurants and airlines since their activities are greatly reduced, if not shut down. In contrast, the consequences of social distancing to fight against the spread of the virus should boost other businesses that offer remote working and communications capabilities -- the video communication specialist Zoom Communications and the tech company Citrix Systems come to mind.

But for IBM (IBM 0.64%), the situation is more complex because of its diversified activities and ongoing transformation. Here are four ways the coronavirus pandemic could impact the 109-year-old tech giant.

1. Global IT spending

From a high-level perspective, IBM's business consists of selling computing infrastructure and services to enterprises. As such, it's exposed to the information technology (IT) global spending that should slow down this year. Because of the coronavirus outbreak, the research company IDC estimates IT spending could increase by only 1% in 2020, down from 4% previously.

But the consequences for IBM could be much more pronounced. With its footprint across many industries in 175 countries, the company also depends on the global economy. Given the wide range of economic forecasts for this year, predictions remain hazardous. But the downside potential seems inevitable. For instance, Reuters reported that Morgan Stanley analysts expected global growth to plunge to global financial crisis lows in 2020.

Some of IBM's segments, such as cybersecurity and cloud, should benefit from the social distancing measures that change the way enterprises work. But given the potential impact of the coronavirus on the worldwide economy, IBM's global business may not thrive in this environment.

Management hasn't updated its guidance yet, but the first-quarter earnings call on April 20 should provide a precious update about IBM's short-term outlook.

Two baby blue clouds on table in front of blurred computer data center background.

Image source: Getty Images.

2. Transition to the cloud 

Over the last several years, IBM has been struggling with diminishing revenue. Because of some asset divestiture and the decline of some of its legacy businesses that deal with on-premises computing infrastructures, revenue dropped from $81.7 billion in 2015 to $77.1 billion in 2019. But the company has been investing in growth areas such as blockchain, artificial intelligence (AI), and cloud computing to offset this decline.

Cloud technology has become a key element of IBM's portfolio. During the last quarter, cloud represented 31.2% of total revenue, up from 4% in 2013, boosted by the acquisition of Red Hat in July 2019.

The immediate impact of the coronavirus on IBM's cloud business remains uncertain. Social distancing means that at least one-third of the worldwide population will stay home, which should increase the consumption of cloud-based services. But the potential slowdown of the global economy could also reduce the demand for IBM's solutions in this area.

Beyond these short-term uncertainties, working from home may become a secular trend. Cloud computing provides the infrastructure to support that shift, which should boost the company's cloud business after the coronavirus situation settles.

3. Reducing the debt load 

Since IBM spent $34.8 billion in cash to acquire Red Hat, its net debt -- total debt minus cash and equivalents -- increased in a meaningful way, from $33.6 billion at the end of 2018 to $53.9 billion at the end of last year. As a result, the rating agency Moody's has downgraded IBM's long-term debt rating from A1 to A2, but that still corresponds to a solid investment grade. In addition, management had expressed its goal of keeping a strong credit rating by reducing the debt load, thanks to the company's strong free cash flow, which reached $11.9 billion last year.

But that was before the coronavirus outbreak. However, that level of free cash flow represents a comfortable safety net to keep on reducing the net debt -- at a slower pace, though -- even if a recession materializes.  

4. Dividend at risk

IBM has been paying a dividend for 104 consecutive years. It's also on the way to becoming a Dividend Aristocrat if it increases its dividend this year, as planned before the coronavirus outbreak.

The free cash flow of $11.9 billion more than covered the $5.7 billion of dividends it paid in 2019. And in January, management said that free cash flow would increase this year, which bodes well for sustaining the dividend. 

However, shareholders should moderate their expectations. Before the pandemic, I had argued a strong dividend increase was unlikely because of the focus on reducing the company's debt load. And depending on the severity of the crisis and its impact on IBM's free cash flow, not increasing -- or cutting -- the dividend has become a possibility. Such a decision may disappoint income-oriented investors, which could have a negative impact on IBM's stock price. 

Herve Blandin has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Moody's and Zoom Video Communications and recommends the following options: short May 2020 $120 calls on Zoom Video Communications. The Motley Fool has a disclosure policy.

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