IBM (IBM -1.05%) has been a bitterly disappointing investment for long-term investors. Over the past 10 years, the tech giant's stock withered by nearly 40%. Even after factoring in its reinvested dividends, it delivered a negative total return of about 4%. The S&P 500 generated a total return of nearly 220% during that same period.
IBM's stock tumbled as the sluggish growth of its legacy IT services, hardware, and business software divisions consistently offset the stronger growth of its newer cloud-based services. Years of divestments, cost-cutting measures, and wasteful buybacks also left it ill prepared to compete in the cutthroat cloud services market.
As a result, many investors might not consider IBM to be a bargain yet, even though it trades at just 14 times forward earnings and pays a hefty forward dividend yield of 5.1%. But if we take a closer look at Big Blue, we'll uncover three key facts that might just change your opinion about this 111-year-old company.
Image source: Getty Images.
1. IBM is finally growing again
In April 2020, IBM's cloud chief, Arvind Krishna, succeeded Ginni Rometty as the company's new CEO. His first major move was to divest IBM's managed infrastructure unit -- which had long been a dead weight on its top-line growth -- as a new company called Kyndryl (KD -3.23%). That spinoff was completed in November 2021, and IBM subsequently restructured its business into three simpler segments: software (41% of its revenue in 2022), consulting (32%), and infrastructure (25%).
All three businesses grew in 2022. Software and consulting revenue each rose 7%, and infrastructure revenue increased 8%. On a continuing-operations basis, IBM's total revenue rose 6% to $60.5 billion for the full year, compared with its 4% growth in 2021. Analysts expect its revenue to rise 4% to $82.7 billion in 2023, in line with Krishna's expectations for "mid-single-digit" revenue growth over the long term.
2. Its cloud business is still growing
Most of that growth has been driven by its hybrid cloud revenue, which rose 11% in 2022 and accounted for 37% of IBM's top line. Hybrid cloud services process the data that flows between public cloud services -- such as Amazon.com's (AMZN 3.43%) Amazon Web Services (AWS) and Microsoft's (MSFT 1.82%) Azure -- and private on-site clouds. Hybrid cloud deployments are generally popular with larger and older organizations that aren't ready to migrate all of their data to public cloud platforms.
Most of IBM's hybrid cloud growth was driven by its acquisition of Red Hat for $34 billion in 2019. Red Hat's open-source software is compatible with a wide range of cloud platforms and enterprise applications, and that universality enables IBM to wedge its data-processing hybrid cloud services between the private and public clouds.
By carving out that niche, IBM doesn't need to go toe-to-toe against AWS, Azure, Alphabet's (GOOG 9.96%) (GOOGL 10.22%) Google Cloud, and other major cloud infrastructure platforms. Instead, that rising tide should lift all boats as more companies tether their private clouds to those public cloud platforms through IBM's services.
3. It still needs to decouple its business from Kyndryl
IBM has parted ways with Kyndryl, but it still sells a lot of its products and services to its former subsidiary. In fact, IBM's sales to Kyndryl still accounted for four percentage points of its top-line growth in 2022 -- so its sales would have risen only 2% without Kyndryl's business.
That's worrisome, because, as an independent company, Kyndryl now has the freedom to shop around and gradually replace IBM's products and services. Kyndryl has already signed cloud partnerships with Amazon, Microsoft, and Google since its split from IBM, and those big deals could significantly reduce its dependence on its former parent company.
Is IBM finally a worthwhile investment?
IBM still faces a lot of near-term challenges, but this isn't the same company that floundered over the past decade as its sales stagnated. Instead, the "new" IBM can more accurately be compared to Oracle, another aging tech giant that successfully rebooted its business by expanding its cloud-based services over the past few years.
IBM's upside potential might be limited until the macroeconomic environment improves and it reduces its dependence on Kyndryl, but its low valuation and high yield could also set a floor under its stock. Therefore, IBM is still a safe stock to buy as the bear market drags on -- but investors should maintain realistic expectations regarding its near-term returns.
