International Business Machines (IBM 0.20%) successfully spun off its managed infrastructure services business late last year. Around $19 billion of annual revenue went out the door, but that revenue was slow-growing and low-margin. What's left of IBM -- high-margin software, a vast consulting business, and specialized hardware -- is no longer being dragged down by that legacy business.
The century-old tech giant now sees growth as the new normal, a sea change from the past decade. With hybrid cloud computing at the center of nearly everything the company does, IBM may finally be ready to emerge from the funk that has kept its stock depressed for years.
"We are seeing very strong demand"
CEO Arvind Krishna said on the first-quarter earnings call Tuesday that the company is "seeing very strong demand" across its software and consulting businesses. Krishna expects demand for technology to grow by as much as 5 percentage points above GDP growth, so sales should keep humming even during a gentle recession.
IBM reported revenue of $14.2 billion and adjusted earnings per share of $1.40 for the first quarter; both numbers were higher than average analyst estimates. Revenue was up 11% year over year adjusting for currency, or up 8% as reported. Sales to Kyndryl Holdings, the stand-alone company that was formed by IBM's managed infrastructure services spinoff, accounted for 5 percentage points of that constant-currency growth.
Consulting was really the star of the show. Consulting revenue soared 17% year over year at constant currency to $4.8 billion, with double-digit growth across all categories and geographies. As businesses and organizations digitally transform their operations, IBM has positioned itself as a trusted partner. Sales to Kyndryl were not a meaningful factor for the consulting business, so this growth was purely organic.
The software business, which includes legacy transaction processing as well as hybrid cloud solutions, also posted solid results. Revenue was up 15% year over year at constant currency to $5.8 billion, although 8 percentage points of that growth were from sales to Kyndryl. IBM now has more than 4,000 clients using its hybrid cloud platform, which is built on Red Hat technology. Red Hat-related signings nearly doubled year to year, a good sign that IBM's hybrid cloud strategy is gaining momentum.
A year of growth
IBM expects to grow revenue by a mid-single digit percentage in 2022 at constant currency, excluding any contribution from Kyndryl. Sales to Kyndryl will add an additional 3.5 percentage points of growth, so high-single-digit growth is to be expected.
One thing that will help this year is the upcoming launch of IBM's latest mainframe, the z16. IBM announced the latest iteration of its iconic mainframe earlier this month, and the systems will be available to customers at the end of May. IBM's mainframes still play a critical role for many companies, powering 45 of the world's top 50 banks, eight of the top 10 insurers, seven of the top 10 retailers, and eight of the top 10 telecommunications companies.
A new mainframe will trigger an upgrade cycle, leading to significant revenue growth in IBM's infrastructure segment for at least a few quarters. IBM's mainframes are also tightly integrated with the company's hybrid cloud solutions, so sales of new systems will drive sales of related products as well as additional financing revenue.
IBM doesn't provide earnings guidance, but it does expect free cash flow to come in between $10 billion and $10.5 billion. That free cash flow number isn't adjusted for cash expenses tied to restructuring, so what you see is what you get.
Shares of IBM rallied on Wednesday following the company's report. IBM needed to change the narrative, and the Kyndryl spinoff may have done exactly that. The story for years has been that IBM is an aging tech giant in decline. With the business now leaner and more aligned to its best growth opportunities, building a track record of growth could go a long way toward convincing investors to give the company a second look.