International Business Machines (IBM +0.00%) posted mixed first-quarter results, and management withdrew guidance because of coronavirus-induced uncertainties. Here are three ways the pandemic is affecting the tech giant.
1. Muddled short-term results
First-quarter revenue increased to $17.6 billion, up 0.1% year over year, adjusted for divestitures and at constant currency. IBM's flattish top line hides a contrasted situation impacted by the coronavirus pandemic.
Some customers changed their priorities to support the sudden increase in cloud computing consumption as employees were required to work from home. That shift boded well for some of IBM's products. For instance, revenue from the company's system hardware segment increased by 10% year over year, boosted by the new mainframe z15.
And consistent with the previous quarter, revenue from cloud increased by 23% year over year at constant currency, partly thanks to the Red Hat acquisition. With $5.4 billion in revenue during the last quarter, cloud represented 30.7% of IBM's total revenue, up from 24.7% the prior year.
However, as a consequence of customers adapting to the coronavirus outbreak, some of the company's businesses declined in a significant way. For instance, as some deals were paused, especially in the retail industry, revenue from IBM's transaction processing platforms segment decreased to $1.5 billion, down 15% year over year. And management indicated during the earnings call this softness should persist during the second quarter, which isn't surprising given the coronavirus situation remains uncertain.
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2. Management withdrew full-year guidance, but dividend seems safe
Like many other companies, IBM withdrew its full-year guidance. Given the impact of the coronavirus on the company's results during the first quarter, this decision makes sense.
CFO James J. Kavanaugh stated during the earnings call: "It is prudent to withdraw our expectations for full year 2020, and we will reassess at the end of the second quarter. Though to be clear, under the various scenarios we ran, we have ample free cash flow and liquidity to support our business and secure our dividend."
Indeed, the dividend seems safe. Before withdrawing its guidance, management had forecasted free cash flow to increase to $12.5 billion this year. But even if the company doesn't reach that objective, trailing-12-month free cash flow of $11.6 billion represents a comfortable margin of safety to pay the dividend, which should represent an annual cash outflow of $5.8 billion.
In addition, net debt -- total debt minus cash and cash equivalents -- decreased to $52.3 billion, down from $53.9 billion at the end of last year. And IBM seems immune from liquidity challenges in the medium term, since it kept a cash balance of $12 billion and over $15 billion of unused credit facilities.
3. Focus on hybrid cloud confirmed
Legacy on-premises computing infrastructures allow people to work from home, but they require the implementation of complex and costly extra solutions. In contrast, cloud computing enables flexible access to scalable resources (such as computing power and storage) from anywhere, which bodes well for IBM's shift to hybrid cloud.
Beyond the immediate boost of the coronavirus pandemic on the company's cloud activities, the new CEO Arvind Krishna confirmed he would keep on focusing on hybrid clouds in the long term.
With this strategy, IBM doesn't compete against Microsoft's Azure and Amazon Web Services (AWS) as a public cloud provider. Instead, it provides solutions for enterprises to use any cloud in a transparent and flexible way, avoiding having their strategic workloads depending on one single cloud vendor.
Arvind Krishna also highlighted the company remained open to acquisitions to accelerate this shift to hybrid clouds. Income investors should stay vigilant, though. Such acquisitions could transform the company's debt load into a burden that could threaten the dividend.
Looking forward
Given the mixed first-quarter results and the withdrawn guidance, the impact of the coronavirus on the company's results over the medium term remains uncertain. Thus, investors should pay close attention to the free cash flow figure in management's next quarterly update. That number will determine whether the company can pay its dividends while keeping the flexibility to reduce its debt load or proceed with acquisitions.
