If you'd forgotten about International Business Machines (IBM -0.35%), you're not alone, and you're forgiven. It used to be royalty within the technology arena, but the company's dominance and stature has been steadily chipped away by newer, better tech solutions. IBM's sales peaked in 2011, beginning a 10-year contraction that by some measures is still underway. The COVID-19 pandemic and last year's spinoff of its managed infrastructure services business Kyndryl continue to obscure its actual results.
The small, quiet crowd talking about IBM, however, is getting bigger as well as louder. They're seeing signs of life from the organization that many had all but given up on. Moreover, the crowd has good reason for its renewed interest.
Turning a big boat around takes time
There's no denying most of IBM's wounds were self-inflicted.
While it hit a wall more than a decade ago when mobile phones evolved into mini-computers with good wireless internet connections, the company was slow to adapt. IBM didn't launch its "strategic imperatives" in earnest until 2014, finally getting serious about cloud computing and data analytics. And even then, the effort never seemed to get much traction. The company acquired Red Hat in 2019, effectively buying its way into the hybrid cloud computing market, yet kicking off a major integration project. Albeit arguably for the best, then-CEO Ginni Rometty stepped down in 2020, prompting even more unknowns headed into the pandemic.
If you can look past all the noise between then and now, though, there's growth-based hope.
Take last quarter's results as an example. Sales were up 8% year over year (11% on a constant-currency basis), largely thanks to firm demand for the hybrid cloud solutions IBM is now able to offer thanks to its Red Hat deal. Artificial intelligence was another key growth driver for the company last quarter. Notably, the company's growth is also no longer crimped by a managed infrastructure business that is viable and profitable, but not exactly expandable.
There's a nuance buried in all the numbers, however, that matters in a big way. That is, sales of cloud computing infrastructure in turn create service and software revenue. Said another way, the company is selling entire ecosystems that serve as cash cows.
Recent comments made by CFO Jim Kavanaugh put this idea in its full perspective. Speaking at Bank of America's recent 2022 Global Technology Conference, Kavanaugh explains that "when we land a hybrid cloud platform [customer], there's an economic multiplier on top of that, $3 to $5 a software for every dollar of platform we land, $6 to $8 of services for every dollar of platform we land. And we're seeing that play out in our consulting business today."
This revenue multiplier is becoming increasingly evident in IBM's accelerating growth, as you'll see in a moment.
Follow the money ... higher
There's still work to be done. While CEO Arvind Krishna has a pretty good handle on the company's hybrid cloud opportunity after two years at the helm, it's still a highly competitive market, and IBM is still figuring out what to do with its remaining legacy businesses. The company is also narrowly focused on hybrid cloud computing, so its solutions on this front have to be reliable and top-notch. Otherwise, any lost business on this front results in a dramatic revenue and earnings contraction.
Doing one thing very, very well, however -- and offering complete hybrid cloud turn-key solutions -- looks like the right shift. Analysts certainly think so, anyway. Now with the effect of COVID-19 fading and without the distraction of Kyndryl, revenue is on a relatively healthy growth trajectory again. At stake is a piece of the growing hybrid cloud market Krishna believes will eventually be worth $1 trillion.
Data source: Thomson Reuters. Chart by author. Revenue and cash flow data is in millions of dollars.
The kicker: While brewing economic turbulence poses a threat to most companies at this time, IBM is apt to hold up against such a headwind. At the BofA conference, Kavanaugh added that "software and consulting now [make up] 70% of our overall portfolio," and then went on to say: "50% of IBM's revenue is recurring revenue." It's an important detail simply because this model lends itself to strong operating margin rates, which in turn "translates into high single-digit free cash flow."
Given that the long-anticipated turnaround is starting to take hold, it's no surprise investors are talking about IBM. And yes, it is quickly becoming a compelling long-term option ... at least for investors with well-diversified portfolios and a five-year to 10-year mindset.
