Everyone is talking about this stock. Is this a good long term option?

If you forgot International Business Machines (IBM -2.04%), you are not alone, and you are forgiven. It used to be royalty in the field of technology, but the dominance and stature of the company has been gradually reduced by newer and better technological solutions. IBM’s sales peaked in 2011, beginning a 10-year contraction that by some measures is still ongoing. The COVID-19 pandemic and last year’s fallout on its Kyndryl managed infrastructure services business continues to cloud its actual results.

The quiet little crowd talking about IBM, however, is getting bigger and louder. They see signs of organizational life that many had practically abandoned. Moreover, the crowd is right about its renewed interest.

Turning a big boat takes time

There’s no denying that most of IBM’s wounds were self-inflicted.

From hitting a wall more than a decade ago when cell phones became mini-computers with good wireless internet connections, the company has been slow to adapt. IBM didn’t seriously launch its “strategic imperatives” until 2014, finally taking cloud computing and data analytics seriously. And even then, the effort never seemed to get much traction. The company acquired Red Hat in 2019, buying its place in the hybrid cloud computing market, while launching a major integration project. Although arguably for the better, then-CEO Ginni Rometty stepped down in 2020, prompting even more unknowns to head into the pandemic.

If you can look past all the noise between then and now, there is hope based on growth.

Let’s take the example of the results of the last quarter. Sales increased 8% year-over-year (11% at constant currency), largely driven by strong demand for the hybrid cloud solutions that IBM is now able to offer thanks to to its agreement with Red Hat. Another key growth driver for the company last quarter was artificial intelligence. Notably, business growth is no longer crimped by a managed infrastructure business that is viable and profitable, but not exactly scalable.

There is a nuance buried in all the numbers, however, that matters a lot. In other words, cloud computing infrastructure sales in turn create service and software revenues. In other words, the company sells entire ecosystems that serve as cash cows.

Recent comments from Chief Financial Officer Jim Kavanaugh put this idea in full perspective. speaking to Bank of Americaat the recent Global Technology Conference 2022, Kavanaugh explains that “when we land a hybrid cloud platform [customer], there is an economic multiplier on top of that, $3-$5 software for every platform dollar we land, $6-$8 services for every platform dollar we land. And we see that playing out in our consulting business today.”

This revenue multiplier is becoming increasingly evident in IBM’s accelerated growth, as you’ll see in a moment.

Follow the money… higher

There is still work to be done. Although 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 also has a strong focus on hybrid cloud computing, so its solutions on this front must be reliable and top-notch. Otherwise, any lost business on this front results in a dramatic contraction in revenue and profits.

Doing one thing very, very well, however – and offering complete turnkey hybrid cloud solutions – seems like the right change. Analysts certainly think so, anyway. Now, with the effect of the disappearance of COVID-19 and without Kyndryl’s distraction, revenues are once again on a relatively healthy growth trajectory. At stake is a portion of the growing hybrid cloud market, according to Krishna, which will eventually be worth $1 trillion.

Data source: Thomson Reuters. Table by author. Revenue and cash flow data are in millions of dollars.

The kicker: Although the brewing economic turbulence poses a threat to most businesses right now, IBM is likely to weather such a headwind. Speaking at the BofA conference, Kavanaugh added that “software and consulting now [make up] 70% of our overall portfolio,” then added, “50% of IBM’s revenue is recurring revenue. This is an important detail simply because this model lends itself to high operating margin rates, which in turn “translates into high margin rates – hard-coded free cash flow.”

As the long-awaited turnaround begins to materialize, it’s no surprise that investors are talking about IBM. And yes, that is quickly becoming a compelling long-term option…at least for investors with well-diversified portfolios and a five- to ten-year mindset.

About Barbara J. Ross

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