Iconic IBM (IBM 2.72%) is in the midst of a turnaround after years of revenue declines. The company is shifting its focus toward cloud computing and artificial intelligence (AI).
After its first-quarter earnings release, IBM stock reached a 52-week high on April 22. Is Big Blue's turnaround showing signs of success?
Let's look at where it is today to assess if now is the time to invest.
Image source: Getty Images.
The company's cloud transformation
IBM's 2021 first-quarter results showed 1% year-over-year revenue growth, the first since the end of 2019. The company's cloud computing businesses were a key contributor, providing $6.5 billion of the quarter's $17.7 billion in revenue. Its first quarter continued IBM's history of double-digit year-over-year growth in cloud revenue.
| Quarter | Total Cloud Revenue | YOY Change |
|---|---|---|
| Q1 2021 | $6.5 billion | 21% |
| Q4 2020 | $7.5 billion | 10% |
| Q3 2020 | $6.0 billion | 19% |
| Q2 2020 | $6.3 billion | 30% |
| Q1 2020 | $5.4 billion | 19% |
Data source: IBM. YOY = year-over-year.
This trend shows the company's cloud strategy is working. IBM focuses on hybrid cloud solutions, which mix on-premises private cloud and public cloud services.
This hybrid solution is particularly compelling to clients requiring a degree of data privacy coupled with the public cloud's cost savings, such as businesses in healthcare and financial services. It's no surprise IBM's offerings won over clients such as Anthem and Pitney Bowes. IBM is even providing cloud-based solutions for the International Space Station.
These clients depend on IBM's cloud technology, making switching costs high and creating a reliable revenue stream. These factors -- combined with spending in the cloud computing industry projected to reach more than $360 billion by 2022 (up from last year's $250 billion) -- mean IBM is likely to see continued cloud revenue growth for some time.
The company's cloud solutions comprised 37% of first-quarter revenue, but its quarterly performance was helped by a 10% year-over-year jump in hardware sales. This was a substantial turnaround from the fourth quarter's 20% year-over-year hardware revenue decline.
Given the cyclical nature of hardware sales, CFO Jim Kavanaugh stated in IBM's earnings call that the company's 2021 full-year guidance doesn't count on continued acceleration of its mainframe business. Even so, IBM's 2021 guidance expects revenue to grow this year.
A tale of two companies
As much as IBM's cloud efforts have proved successful, the IT industry's cloud services shift hurt its legacy businesses. Among these, the company's Global Technology Services division is the largest, representing 36% of first-quarter revenue.
But while IBM's cloud sales saw year-over-year growth during the last five quarters, Global Technology Services experienced revenue declines over the same period.
| Quarter | Global Technology Services Revenue | YOY Change (Decline) |
|---|---|---|
| Q1 2021 | $6.4 billion | (1.5%) |
| Q4 2020 | $6.6 billion | (5.5%) |
| Q3 2020 | $6.5 billion | (4%) |
| Q2 2020 | $6.3 billion | (8%) |
| Q1 2020 | $6.5 billion | (6%) |
Data source: IBM. YOY = year-over-year.
To accelerate IBM's focus on cloud solutions, the company decided to spin off its managed infrastructure services, which reside under Global Technology Services, into its own publicly traded company called Kyndryl. The spinoff is expected to be complete by the end of 2021.
Any investment in IBM stock today means ownership in both IBM and Kyndryl after the spinoff. But is Kyndryl worth owning? According to IBM, Kyndryl will be the leader in its field with "more than twice the scale of its nearest competitor." It will have over 4,600 clients, including more than 75% of the Fortune 100. Investors must wait for Kyndryl's Form 10 registration, expected in the fall, to gain greater clarity on the new company.
The bottom line
So is now the time to buy IBM stock? The company certainly possesses many attractive qualities. Its cloud strategy is sound, and there's a dependable dividend. It has raised the payout annually for the past 25 years and has paid consecutive quarterly dividends since 1916.
IBM's solid free cash flow means the dividend is secure. In 2020, the company generated $10.8 billion in free cash flow, paying out $5.8 billion in dividends. It expects 2021 adjusted free cash flow to be at least $11 billion, excluding costs related to the spinoff.
IBM's revenue growth will improve once its managed infrastructure services are no longer weighing down company earnings. But despite these positives, I recommend waiting to buy given the impending spinoff.
Once Kyndryl's Form 10 is available, investors can evaluate IBM and Kyndryl independently. From there, you can assess if Kyndryl is a worthwhile investment. Until then, it's best to wait on IBM stock.
