A Surprising – and Formidable — Cloud Competitor
In 1928, this company created the first public address system for schools. Who knew? Five years later, it began producing electric typewriters. It invented the first completely electronic computing machine in 1943 and launched the first consumer desktop computer in 1981. In 1996/97, its artificial intelligence offering, Deep Blue, beat world chess champion Garry Kasparov after losing an earlier match.
By now, you know I’m referring to International Business Machines (IBM), whose 9,262 U.S. patents in 2019 alone topped the list of most U.S. patents received for the 27th consecutive year.
These days, IBM has its sights set on one of the fastest-growing and most-lucrative sectors in the tech space. And what’s bad news for competitors could be good news for investors. Adam Fischbaum explains.
— Bob Bogda, Editor
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In the 2014 comedy “Sex Tape,” a husband and wife, played by Jason Segal and Cameron Diaz, make a racy home move that is inadvertently uploaded to an adult video-sharing site in the cloud. Panic ensues. She: “And you can’t get it down from the cloud!?!” He: “Nobody understands the cloud! It’s a mystery!”
That was then. This is now: Global revenue from cloud computing services is expected to come in at $257.9 billion this year, more than four and a half times the amount in 2014.
What may not have been understood in 2014 is crystal clear today.
First, the basics: Cloud computing is the term used for the delivery of computer services such as servers, storage, databases, networking, software or analytics via the internet. Thanks to cloud services providers, companies no longer need rooms full of servers. Everything is “in the cloud.”
According to ZDNet, citing data from market research firm IDC, public cloud spending passed traditional IT infrastructure for the first time in the second quarter of 2020, spurred in part by pandemic-induced work from home and video conferencing. During the April-June period, public and private spending on cloud environments rose 34.4% from a year earlier, while non-cloud IT spending fell 8%.
The biggest cloud-services providers are the usual suspects. The top four: Amazon (AMZN) through Amazon Web Services (referred to as AWS), which commands a third of the market; Microsoft (MSFT) through Microsoft Azure, with an 18% market share; Google’s (GOOG) Google Cloud Platform at 9%, and the grandfather of computing IBM’s (IBM) IBM Cloud, with an 8% share.
Wait. International Business Machines? The company that was founded more than a century ago as the Computing-Tabulating-Recording Company? The company that earned a name for itself with punch-card data-processing machines?
And going forward, the top three will need to watch their backs. This isn’t your grandfather’s staid Big Blue with its gray suited, red tied, white shirt army of salesmen marching in lockstep. It’s an aggressive player that – in recent years, especially – is willing and able to go where the action is.
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The writing was on the wall twenty years ago. That’s when IBM began the pivot from a hardware company to a software and services company.
That pivot was marvelously executed. Today, 57% of the company’s revenue mix comes from global technology (IT) and business services, while only 13% comes from legacy mainframe systems.
But IBM’s most exciting revenue producer is the cloud and cognitive software (artificial intelligence/AI) business, which already commands a 30% piece of the pie.
Last year, IBM showed its commitment to the cloud with its $34 billion acquisition of open source, cloud software provider Red Hat. Combining this with its artificial intelligence (AI) division that developed the acclaimed Watson system, Blue’s cloud business generated $23 billion last year and is poised to grow that share.
In fact, on October 8, IBM announced plans to spin off its legacy managed-infrastructure business into a separately traded entity. The remaining business will focus primarily on what it calls “hybrid cloud computing,” which it sees as a $1 trillion+ market.
Just as the company’s vision is focused and articulated, IBM’s metrics are ironclad. From $75.5 billion in annual revenue, the company throws off $5.55 billion in annual free cash flow, which is the money that’s left after all the bills are paid.
During her tenure as CEO, which began in 2012, Gina Rometty tightened up the operation to turn in a remarkable 41.3% return on equity (ROE). That compares with a 20.8% ROE from Amazon, 15.8% from Alphabet and 11.3% from Oracle (ORCL).
In April, Rometty handed over the reins to Arvind Krishna, a 30-year Big Blue vet who, up until his ascension to CEO, built out and ran the cloud and cognitive division.
In other words, he’s the right guy at the right time.
Revenue in the cloud and cognitive segment is growing at a 23% year-over-year rate. Not bad for one-third of your income. Once the spinoff is complete, cloud and cognitive contribution will be over 45% of the revenue for the new company. Under Krishna’s leadership, the stars are lining up.
IBM is going to be a pure-play cloud services business. They’ve said so themselves with the planned spinoff of the legacy systems and business services units. This is a great opportunity for conservative investors who want high-tech stock exposure without the high-tech price tag of most of the companies in the space.
Currently, the stock trades at around $126 with a cheap forward PE of 11.34. The dividend yield is an attractive 5.19% (considerably higher than its peers) and has grown at an annual rate of 5% over the last five years.
Action to Take: Consider buying IBM at current prices and hold it for the long term while enjoying the compounding provided by the large dividend and foreseeable growth.
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