IBM's (IBM 1.56%) stock price rallied 9% to an 11-year high on Jan. 25 after the tech giant posted its fourth-quarter earnings report. Its revenue rose 4% year over year to $17.4 billion, which exceeded analysts' estimates by $100 million. Its adjusted earnings grew 8% to $3.87 per share and also cleared the consensus forecast by $0.07 per share.
That earnings beat suggests that IBM's turnaround efforts under CEO Arvind Krishna, who took the helm in April 2020, are finally bearing fruit. But can Big Blue ever fully reinvent itself like Microsoft, which became a high-growth tech giant again over the past decade as it expanded its cloud-based ecosystem?
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Why did IBM need a turnaround plan?
From 2010 to 2020, IBM's annual revenue decreased from $99.9 billion to $55.2 billion. That persistent decline was caused by two major mistakes.
First, IBM's core business software, IT infrastructure, and mainframe divisions struggled as more companies shifted toward cloud-based services. Second, it divested many of its lower-margin segments, which reduced its total revenue.
Streamlining its sprawling business initially seemed like the right move, but it plowed most of its cash from its divestments into wasteful share buybacks instead of making meaningful investments in its own cloud ecosystem. By the time IBM finally started focusing on the cloud, it had already lost the public cloud platform market to Amazon, Microsoft, and Alphabet's Google.
Those missteps caused many investors, including Warren Buffett, to abandon IBM. From the beginning of 2010 to the end of 2020, its stock declined 4% as the S&P 500 advanced 237%. Even after factoring in reinvested dividends, IBM only delivered a total return of 38% compared to the S&P 500's total return of 322%.
NYSE: IBM
Key Data Points
How is Krishna trying to turn around IBM?
Arvind Krishna and Microsoft's Satya Nadella both led their companies' cloud divisions prior to taking on their CEO roles. That's why it wasn't surprising when Krishna, like Nadella, immediately prioritized the expansion of IBM's cloud business.
Krishna's first big move was the divestment of its slower-growth managed infrastructure services unit. Kyndryl spun off in November 2021, enabling IBM to focus on expanding its higher-growth hybrid cloud and artificial intelligence (AI) businesses.
Realizing that IBM couldn't go head-to-head against Amazon, Microsoft, and Google in the public cloud, Krishna prioritized the development of hybrid cloud services that could process the data that flowed between private and public clouds. The crux of that strategy is its Red Hat subsidiary, which develops open-source software for a wide range of computing platforms. The expansion of that hybrid cloud should also support its development of AI tools for processing all of that data.
Will that turnaround lead to bigger gains for IBM?
At the end of 2021, IBM restructured its business into three simpler reporting segments -- software, consulting, and infrastructure -- and set a goal of generating "sustainable mid-single digit revenue growth" from 2022 to 2024. At the time, it expected the mid-single-digit growth of its software business and the high-single-digit expansion of its consulting segment to offset the "flat" growth of its infrastructure division.
|
Segment |
2022 Revenue Growth |
2023 Revenue Growth |
|---|---|---|
|
Software |
7% |
5% |
|
Consulting |
7% |
5% |
|
Infrastructure |
8% |
(5%) |
|
Total revenue |
6% |
2% |
Data source: IBM.
IBM easily cleared those targets in 2022, but the slower-than-expected expansion of its consulting and infrastructure divisions throttled its growth throughout 2023. But most of that deceleration occurred in the first half of the year, and its growth accelerated again in the second half as its consulting and infrastructure businesses recovered.
For 2024, it expects its revenue to rise by the mid-single digits on a constant currency basis, with currency headwinds reducing its reported revenue by a single percentage point. That's in line with analysts' expectations for 3% growth.
But can IBM pull off a Microsoft-like turnaround?
IBM's prospects are brightening, its stock still looks cheap at 19 times forward earnings, and it pays a hefty forward yield of 3.8%. For value investors, it might look more appealing than Microsoft, which trades at 37 times forward earnings and pays a paltry forward yield of 0.7%. But Microsoft is also growing a lot faster than IBM: Analysts expect its revenue and earnings to both rise 15% this year as it expands its cloud and AI businesses.
Therefore, I think it's premature to call IBM the next Microsoft. A few green shoots are appearing, but IBM is still trying to carve out a defensible niche with its newest cloud and AI services, while Microsoft remains a clear leader in both markets. IBM could stabilize its aging business with single-digit revenue growth over the next few years, but it shouldn't be seriously compared to Microsoft until it fires up a few more growth engines.
