It’s been a long slog for IBM (NYSE:IBM) investors over the past few years. The firm has been promising a turnaround for what feels like forever but has yet to produce growth that sticks. However, IBM’s recently completed purchase of Red Hat could be the catalyst that finally turns IBM stock around.
A big part of the reason that IBM’s stock price has been struggling over the past decade is the fact that management missed the boat on cloud computing. While competitors wholeheartedly put their energy into building out impressive cloud businesses, Big Blue stuck to what it knew, and as a result, its business became antiquated and profits slid.
However, management has since put a lot of focus on IBM’s cloud arm and that could start paying off in the next few quarters. In the second quarter, IBM’s Cloud & Cognitive Software segment saw its revenue rise 3.2%, a bright light in an otherwise gloomy Q2 report. Of course, that kind of growth in cloud computing is well behind competitors like Microsoft (NASDAQ:MSFT).
Red Hat Benefits
However, IBM’s acquisition of Red Hat could make Big Blue’s cloud arm much more appealing and further boost revenue in the years to come. Red Hat’s dominance in the open-source cloud computing space should boost demand for IBM’s cloud offerings, which in turn will aid in the firm’s overall recovery.
Having Red Hat under the IBM umbrella should boost IBM’s business in several ways, including by selling IBM software to Red Hat users and vice-versa. The financial impact of the cross-selling will be substantial, but even more importantly the added capabilities that Red Hat provides to IBM’s cloud business should help the firm gain market share as more and more business functions are shifted to the cloud.
Revenue Growth
The biggest thing holding International Business Machines stock back is the firm’s inability to deliver consistent revenue growth. IBM was able to break a 23-quarter losing streak at the end of 2017, but that revenue growth was short-lived with the firm delivering losses in each of the last four quarters.
However, while the Red Hat acquisition was expensive and might continue to weigh on IBM stock in the near-term, things look likely to pick up in 2020 and beyond. IBM’s management said it sees revenue rising by 4-5 percentage points in 2020 and estimates that Red Hat will add $500 million to the firm’s free cash flow as well.
Upside Ahead
As UBS analyst John Roy pointed out in his coverage on IBM stock, the cross-selling between IBM and Red Hat is enough to bring the share price higher. The additional benefits of improving IBM’s cloud performance and pulling up the firm’s other businesses would be a cherry on top.
That means whether you believe that IBM has the potential to orchestrate a groundbreaking turnaround or not, there’s likely upside on the horizon as the Red Hat synergies are realized.
Trade War Woes
Another weight around IBM stock’s neck has been the ongoing trade tension with China. The most recent rhetoric between Beijing and DC took the market lower once again, but most are predicting an upswing in the future. InvestorPlace’s Luke Lango pointed out that history has shown us that the trade war seems to be stuck in a cycle and that the upturn is on the horizon.
The Bottom Line on IBM Stock
There’s a lot to like about IBM stock right now. I’ll admit it’s taken a long time to get to this place, but Big Blue looks likely to break out over the next six months. If the firm’s Red Hat acquisition is as beneficial as management has predicted, the firm’s upcoming quarterly results could be something to celebrate.
If trade war tensions die down over the next few months and IBM’s results back up management’s grand plans, it could be a perfect storm for International Business Machines investors. Plus, IBM stock offers a 4.66% dividend yield that looks relatively safe— which should make the near-term volatility a bit more comfortable.
As of this writing, Laura Hoy was long IBM.
