IBM (IBM -0.89%) stock lost nearly 30% of its value over the past decade as it struggled with the sluggish growth of its legacy businesses.
But over the past year, Big Blue started turning a few heads with its aggressive turnaround strategies. Arvind Krishna, the former cloud chief who succeeded Ginni Rometty as IBM's CEO in April 2020, orchestrated the spin-off of Kyndryl (KD -0.30%), which contained its struggling managed infrastructure services unit, to streamline IBM's core business and focus on the expansion of its hybrid cloud and AI services.
IBM spun off Kyndryl last November, and its stock price has risen 8% since that separation. Its fourth-quarter report on Jan. 24 also beat analysts' expectations on the top and bottom lines. Could IBM finally be poised for a comeback? Let's compare the bear and bull cases to decide.
Image source: Getty Images.
What the bears believe about IBM
The bears dislike IBM for three reasons: Its cloud growth was unimpressive under Krishna, it faces tough competition in the hybrid and AI markets, and it's still juggling a lot of slower-growth businesses.
IBM's total cloud revenue -- which includes all of its private, hybrid, and public cloud-oriented businesses -- rose 19% to $25.1 billion in 2020. Instead of disclosing its total cloud growth for 2021, it said its hybrid cloud revenue grew 20% (19% in constant currency terms) to $20.2 billion.
That growth rate seems stable, but it still trails far behind those of public cloud leaders like Amazon (AMZN -1.14%) Web Services (AWS), which grew 39% year over year in its latest quarter; or Microsoft's (MSFT -1.84%) Azure and Alphabet's (GOOG 0.37%) (GOOGL 0.35%) Google Cloud, which both grew more than 40% year over year in their latest quarters.
Those public cloud services disrupted IBM's managed infrastructure and software businesses, and IBM's own public cloud services couldn't gain much traction against those market leaders. As a result, IBM retreated to the hybrid cloud market -- which wedges various data processing services between private clouds and public cloud platforms like AWS and Azure.
IBM believes its $34 billion acquisition of Red Hat, which closed in 2019, will help it secure that niche with open source software that is compatible with a wide range of on-site software and public cloud platforms.
That sounds like a promising plan, but the software segment that includes all of IBM's hybrid cloud, AI, security, and transaction processing segments only accounted for 44% of IBM's revenue last quarter. The consulting segment accounted for 28% of its revenue, while 26% came from its struggling infrastructure business, which includes its slower-growth hardware, public cloud, and edge computing businesses.
IBM expects the infrastructure unit's "mid-term" (2022-2024) revenue to stay flat, and that sluggishness could offset the mid-single-digit growth of its streamlined software segment. The consulting business, which IBM expects to generate high-single-digit sales growth, could also struggle to compete against nimbler rivals like Accenture and Globant.
Lastly, Amazon, Microsoft, and Google are all expanding into the private and hybrid cloud markets. All three companies already provide virtual private clouds (quarantined regions of the public cloud) as alternatives to on-site private clouds, along with hybrid cloud services that bridge the gap between the two platforms. These services could prevent IBM's software segment from carving out a defensible niche in the hybrid cloud market.
What the bulls believe about IBM
The bulls generally like the "new" IBM for four reasons: The hybrid cloud market is still expanding, it's set firm growth targets through 2024, the stock is dirt-cheap, and it pays a high dividend.
The hybrid cloud market could grow at a compound annual growth rate (CAGR) of 21.1% between 2021 and 2026, according to Mordor Intelligence, as larger companies opt to split their data between private and public cloud services. That trend will likely drive demand for hybrid cloud and AI services that can process all that data.
Therefore, there could still be plenty of room for IBM, Amazon, Microsoft, and Google to grow in the cloud market without trampling each other. IBM can also leverage its existing relationships with large companies, as well as the flexibility of Red Hat's software, to expand its hybrid cloud business.
IBM management said it believes that IBM can generate sustainable mid-single-digit percentage revenue growth, or about $3 billion in fresh sales each year, between 2022 and 2024. That forecast would be unremarkable for most blue-chip tech companies, but it would mark a stunning turnaround for IBM, which posted annual revenue declines throughout most of the previous decade:
Source: YCharts
IBM management said it believes the divestment of Kyndryl and the expansion of its software and consulting divisions will help IBM achieve that goal. If it generates stable revenue growth again, IBM's stock -- which trades at just 12 times forward earnings -- might attract a lot more attention. Income investors might also be drawn to its forward yield of 4.8% and its status as a Dividend Aristocrat again.
Which argument makes more sense?
After jettisoning Kyndryl, IBM looks like a much healthier investment. However, it's still too difficult to tell if the slimmed-down company can actually grow its annual revenue by the mid-single-digits again. IBM's low valuation and high dividend should limit its downside potential, but I'd personally rather stick with other blue-chip tech stocks until a few more green shoots appear.
