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5 Things to Know About IBM's Earnings Report

International Business Machines (NYSE: IBM) didn't disappoint when it announced its first-quarter results on Monday. The century-old tech giant returned to revenue growth and beat analyst estimates for both the top and bottom lines. Solid growth in cloud computing and a strong performance from the mainframe business helped the cause.

Here are five key things to know about IBM's results.

Double-digit cloud growth

IBM offers a public cloud platform similar to market leaders Amazon Web Services and Microsoft Azure, but the company's main focus is on hybrid cloud computing. IBM is betting that its base of large customers will benefit from mixing on-premises hardware and public cloud services, instead of simply going all-in on public cloud.

IBM delivered 18% cloud revenue growth in the first quarter. Within the cloud and cognitive software segment, cloud revenue grew by 34%, and the company now has approximately 3,000 hybrid cloud platform clients. Cloud revenue was up 28% in the global business services segment, up 2% in the global technology services segment, and up 21% in the systems segment.

Strong growth for Red Hat

IBM announced the $34 billion acquisition of open-source software company Red Hat in late 2018, and it completed that acquisition in mid-2019. Accounting rules prevented IBM from recognizing all of the revenue Red Hat was generating following the acquisition, but the company is now lapping those periods.

IBM recognized 53% more revenue from Red Hat in the first quarter than it did in the prior-year period. The real growth rate for Red Hat was much lower but still impressive. Adjusted for both the accounting rules and currency, Red Hat grew revenue by 15% year over year.

Since closing the acquisition, IBM has tripled the revenue base for Red Hat's OpenShift hybrid cloud platform. Red Hat's software is a key part of IBM's hybrid cloud strategy, and the company has a huge opportunity to sell its existing clients on Red Hat's platform.

Image source: Getty Images.

The mainframe is still going strong

IBM introduces a new mainframe system every few years, kicking off an upgrade cycle that temporarily spikes revenue in the systems segment. While mainframes may seem outdated, the systems are still used extensively in industries like financial services. IBM's mainframe revenue grew by 49% year over year in the first quarter. That kind of growth nearly two years after launching the latest mainframe is not typical for IBM.

IBM's mainframe business drives sales of software and services, including sales of Red Hat's platform. OpenShift runs on IBM's mainframes, so the systems are a part of IBM's hybrid cloud strategy. Mainframe sales will eventually taper off as the product cycle ages further, but it provided a nice boost to revenue in the first quarter.

Debt is being paid down

IBM loaded up its balance sheet with debt to fund the Red Hat acquisition. The company is making progress strengthening its balance sheet.

IBM ended the first quarter with $56.4 billion in total debt, down from $64.3 billion one year prior. About $18 billion of that debt is tied to IBM's global financing business, while the rest is not. The non-global financing debt has been reduced by $4 billion over the past year to $38.1 billion.

On top of chipping away at its debt load, IBM has maintained a healthy cash balance. The company had $11.3 billion of cash and marketable securities at the end of the quarter, down slightly from the same period last year.

The guidance is unchanged

IBM is sticking to its previously issued guidance for 2021. The company expects to produce revenue growth for the full year, and it sees adjusted free cash flow between $11 billion and $12 billion.

That free cash flow number excludes a few significant items. First, it backs out about $3 billion related to restructuring initiatives began late last year. Second, it excludes any costs associated with the planned spin-off of the managed infrastructure services business. That spin-off is expected to be completed by the end of the year.

Is it time to buy IBM stock?

While IBM grew revenue in the first quarter and beat analyst estimates across the board, the company still has a lot of work to do to prove to investors that this growth is sustainable. Legacy businesses are still dragging down the company's results, a situation that will be helped by the upcoming spin-off.

IBM stock is trading at depressed levels relative to earnings. Analysts expect IBM to report around $11 in per-share adjusted earnings this year, putting the forward price-to-earnings ratio at just about 12.5. The company also pays a dividend that currently yields about 4.7%.

If IBM's hybrid cloud strategy pans out, a combination of earnings growth and multiple expansion could deliver solid returns for patient investors.

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Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Timothy Green owns shares of IBM. The Motley Fool owns shares of and recommends Amazon and Microsoft. The Motley Fool recommends the following options: long January 2022 $1920.0 calls on Amazon and short January 2022 $1940.0 calls on Amazon. The Motley Fool has a disclosure policy.


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