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Investors Looking for Tech Dividends Might Want to Give IBM Stock Another Chance

By Nicholas Rossolillo - Jan 28, 2021 at 7:58AM

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Just understand that patience will be necessary.

IBM (IBM -0.91%) recently reported its full-year 2020 financial results to a ho-hum investor reception. Big Blue's revenue remains in stubborn decline, dragged down by its legacy operations that become less important every year as cloud computing demand grows. But hiding just below the surface is a very healthy and growing "hybrid cloud" business. IBM is taking steps to refocus its attention here, but it takes time for an old company like this to bring about fundamental change. Patience will be required, but dividend investors might want to give this stock another chance.

How big is hybrid cloud for IBM?

As for those lackluster results, IBM reported full-year 2020 revenue of $73.6 billion, down 4% from 2019 when excluding divestitures and foreign currency exchange rates. Free cash flow was down 9% year over year to $10.8 billion.  

The good news here is that IBM is still a highly profitable company, and the free cash flow it generated in the last year was more than enough to cover its dividend payment (which cost it a total of $5.8 billion in 2020 and is currently good for an annual yield of 5.5%) and service its sizable load of debt ($61.5 billion at the end of the year). And as of this writing, IBM stock trades for just 10 times trailing 12-month free cash flow. For me, this old technologist is just too cheap to ignore.

A cloud surrounded by computers, illustrating cloud computing.

Image source: Getty Images.

However, a cheap stock alone is not a good reason to invest. What really has me interested is the hidden value that could be unlocked once IBM spins off its managed infrastructure business as a separate entity by the end of this year. It won't be a total offloading of its old tech, but it will be a sizable chunk of stagnant IBM that will leave what remains to focus on the "hybrid cloud" industry -- a high-growth area the company jump-started with its acquisition of Red Hat over the summer of 2019. Hybrid cloud refers to an organization's cloud computing infrastructure that utilizes both a public and private cloud (computing taken care of via a data center and accessed via an internet connection), or multiple public and private cloud services that need to be managed.  

Just how big is this hybrid cloud business? It brought in $25.1 billion in 2020, just over one-third of total revenue. Cloud revenue increased 19% year over year, illustrating just how big of a drag the rest of the company's operations have been on this promising segment. In fact, IBM's hybrid cloud segment puts it in third place in the still-nascent cloud industry, behind only Microsoft and Amazon -- not terrible company to be in by any stretch. And given the expectation the cloud industry will be a double-digit percentage growth segment of the economy for the foreseeable future (with $1 trillion annual global spending up for grabs), it makes sense IBM wants to whittle down its operations to this modern essential of the tech universe.  

Ignore the top-line print for now

A lot of work will need to be done for IBM to pull this off, though, and shareholders may not see top-line revenue turn a corner until the company completes its spinoff later this year. Patience will be required, but much effort is being made behind the scenes. CEO Arvind Krishna, who took the reins last spring, is trying to rewrite company culture to match the fast-moving high-tech world we now live in. 

On the fourth-quarter 2020 earnings call, Krishna talked about some of the changes. Partnerships are being formed with the likes of on vaccine distribution and blockchain-based healthcare data technology. IBM's sales teams are being simplified to make them more responsive to customers. Krishna is also encouraging more risk-taking to foster an entrepreneurial spirit within the company. Spinning off the older managed infrastructure business (no doubt along with some of its debt) will make the new IBM leaner and better suited to this new culture Krishna is trying to build.  

But I'll reemphasize patience is a must-have in this situation. Until the spin-off happens, assume IBM will continue to post lackluster-at-best top line results. In the meantime, shareholders get treated to the dividend payment, but the bigger payoff will come once IBM is free of some of its legacy businesses and is able to fully turn its attention to hybrid cloud. Given the sheer size of global cloud spending, I think IBM deserves a serious look.

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