Send me real-time posts from this site at my email

IBM Is Growing Again After Kyndryl Spin-Off

International Business Machines (NYSE: IBM) has spent the better part of a decade transforming itself into a cloud-computing and AI-focused company. It hasn't been a smooth ride. While the cloud business has been growing at double-digit rates, slow-growing, low-margin legacy businesses have been dragging down the century-old tech giant.

IBM completed the spin-off of Kyndryl, its managed infrastructure-services business, in November, shedding around $19 billion of annual revenue in the process. What remains of IBM is leaner, more focused, and more capable of producing consistent growth. The company's first earnings report since the separation gives investors a glimpse of what they can expect from the new IBM.

Image source: Getty Images.

Solid growth with a boost from Kyndryl

Kyndryl is an IBM customer, and that relationship is producing revenue for IBM now that Kyndryl is its own company. Even without factoring in the Kyndryl revenue, though, IBM's fourth-quarter report looked good.

Total revenue rose 9% year over year to $16.7 billion, or 5.5% excluding incremental sales to Kyndryl. From this revenue, IBM produced $3.5 billion of pre-tax income.

The software segment, which includes Red Hat, grew revenue by 10% to $7.3 billion. Kyndryl was responsible for half of that growth, largely due to sales of transaction-processing products. Consulting revenue soared 16% to $4.7 billion, and infrastructure revenue jumped 2% to $4.4 billion.

Hybrid cloud, a category that spans all of IBM's segments and encompasses anything related to cloud computing, has produced $20 billion of revenue over the past year, up 19%. In the software segment, IBM offers cloud platforms and solutions. In the consulting segment, IBM helps customers digitally transform their businesses for the cloud era. And in the infrastructure segment, IBM sells mainframe systems and other hardware that enables hybrid cloud computing, as well as public cloud and support services.

An incomplete outlook

IBM expects 2022 to look like the fourth quarter. The company sees revenue growing by a mid-single-digit percentage excluding the impact of currency, with another 3 percentage points tacked on from sales to Kyndryl. Free cash flow should be between $10 billion and $10.5 billion.

A new mainframe will likely provide a boost this year. The current mainframe cycle is more than 2 years old, so a new model should be right around the corner. Mainframe launches induce some of the installed base to upgrade, producing a spike in revenue for IBM's infrastructure segment.

IBM neglected to provide guidance for earnings per share (EPS), instead choosing to focus on revenue and free cash flow. "[T]hat focus is around two measures: revenue growth and free cash flow. So, I am not going to talk about EPS guidance," said CFO Jim Kavanaugh during the earnings call with analysts.

EPS can be hard to predict. It's an accounting number that's affected by a lot of things and not always a good representation of profitability. Free cash flow is, in some ways, a better number, but neither metric on its own tells the whole story. It's somewhat concerning that IBM is not providing EPS guidance, but the company may just want investors to focus on its actual cash generation, instead.

A new era for IBM

With the separation of Kyndryl complete, IBM's growth profile looks a whole lot better. Software and consulting now account for more than 70% of revenue. Software is the most profitable part of IBM, generating pre-tax margins close to 30%. Consulting is less profitable but feeds into the software business. IBM can turn clients looking to transform themselves for the hybrid-cloud era into Red Hat customers.

If IBM can consistently hit its long-term targets of mid-single-digit revenue growth and high-single-digit free cash flow growth, the stock could be a big winner in the coming years. IBM is valued around $120 billion, roughly 12 times the free cash flow guidance. The market just doesn't believe in IBM's growth story.

Skepticism is certainly warranted. IBM stock has been a disaster over the past decade, and the turnaround has never quite taken hold. Here's hoping it's different this time around.

10 stocks we like better than IBM
When our award-winning analyst team has a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

They just revealed what they believe are the ten best stocks for investors to buy right now... and IBM wasn't one of them! That's right -- they think these 10 stocks are even better buys.

See the 10 stocks

*Stock Advisor returns as of January 10, 2022

Timothy Green owns IBM and Kyndryl Holdings, Inc. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.


Popular posts

Welcome! Is it your First time here?

What are you looking for? Select your points of interest to improve your first-time experience:

Apply & Continue