International Business Machines (IBM +0.98%), a company that has been largely written off by investors over the past decade, is having a moment. A yearslong transformation effort has rejiggered the company's portfolio, aligning it on two priorities: Hybrid cloud computing and artificial intelligence. In both areas, IBM's strength lies in its ability to offer full-scale solutions to its enterprise clients.
AI is still a small business for IBM, but it's growing incredibly fast. The company's secret weapon is its consulting business. "Consulting is a core driver of our value proposition for clients," said IBM CEO Arvind Krishna in the fourth-quarter earnings call. IBM provides an AI software platform called watsonx that enables its clients to train, deploy, and manage AI models, but it's the guidance and implementation expertise provided by the company's consulting arm that's closing deals.
NYSE: IBM
Key Data Points
Soaring demand for generative AI
At the end of the third quarter, IBM's book of business related to generative AI and watsonx was in the low hundreds of millions of dollars. This isn't revenue, but instead the amount that clients are committing to spend. That amount doubled in the fourth quarter. Software drove just one-third of this business, with consulting signings driving the remaining two-thirds. Clearly, the consulting arm is doing the heavy lifting.
This makes sense. Large enterprises have complex requirements when it comes to AI, so adopting generative AI technology is not a cut-and-dried process. One example IBM gave during its fourth-quarter earnings call was a pilot with banking giant Citigroup that involved the watsonx code assistant.
IBM's mainframe systems are still prolific in certain industries, including banking. Much of the mission-critical code running on these systems is written in an ancient programming language called COBOL. The problem is that no one really learns COBOL anymore. As time goes on, the pool of developers capable of maintaining these COBOL applications dwindles.
IBM introduced an AI tool called watsonx code assistant last year that aims to solve this problem for its clients. The tool uses generative AI to map out a COBOL application, split it up into parts, and convert it to a more modern programming language. The most advanced large language models available publicly are capable of writing code, but a company like Citi certainly isn't going to send ChatGPT critical, sensitive banking code. Instead, it needs a secure AI platform that it can trust, along with guidance and expertise to make the best use of it. That's the IBM AI value proposition in a nutshell.
Buy this AI stock now
IBM has a clear AI strategy that leverages its AI software platform and its consulting arm to help clients adopt the revolutionary technology. The revenue contribution from AI is still small, and it will take time for the commitments from clients to convert to actual sales. But in the long run, AI can turn into a multi-billion dollar business for IBM.
Gartner predicts that global spending on AI software alone will approach $300 billion by 2027, with generative AI software accounting for more than one-third of that total. IBM's opportunity is even bigger than that, though, since it also offers consulting services around AI. As enterprises race to adopt this technology, IBM offers solutions, not just point products.
Even after a post-earnings surge, IBM stock remains inexpensive. With a market capitalization that's approaching $170 billion and guidance calling for free cash flow of $12 billion this year, the stock trades at a price-to-free cash flow ratio of about 14. As the AI business scales, IBM's revenue growth could accelerate from the mid-single-digit growth it expects for 2024.
With an enterprise AI software platform paired with its vast consulting arm, IBM is in a unique position to win AI business from enterprise clients.
