Big Blue doesn’t get much love and it hasn’t for quite some time. International Business Machines (NYSE:IBM) has floundered over the years, with IBM stock down about 16% over the past five years.
That may all be changing, though.
We’re now seeing some of the company’s pivots taking hold. A management shakeup should lead to fresh opportunities, while the company’s new update has investors excited.
As a result, shares were up as much as 9.2% on Thursday, Oct. 8.
Focusing on the Cloud
On Oct. 8, IBM shook things up. After a decade-plus of underperformance, it was time for some change. The company already changed its CEO earlier this year and closed on its acquisition of RedHat in July 2019. But it needed more.
The company now announced its plan to spin off its infrastructure unit in a tax-free deal. IBM will then focus its efforts on the cloud and maximizing its opportunity in an industry that has allowed other companies to balloon into mega-cap tech stocks.
There is a headline in the press release that reads: “IBM, a Leading Hybrid Cloud and AI Company.”
If management makes the above statement true, then the stock could be a real winner down the stretch. IBM isn’t known for its robust growth — just the opposite, actually. However, it had a huge list of big-name clients and government contracts that could help deliver the growth management is craving.
The company also wrote:
IBM’s open hybrid cloud platform architecture, based on RedHat OpenShift, works with the entire range of clients’ existing IT infrastructures, regardless of vendor. This platform allows clients to “write-once/run-anywhere,” and enables a hybrid cloud approach that drives up to 2.5 times more value for clients than a public cloud-only solution.
IBM’s software portfolio, focused on data and AI, automation, and security, enables the widest access to innovation through open source.
Changes like this don’t happen overnight. It takes time to spin off an entity (likely over a year in this case) and pivot a company like IBM. But these are the types of transformational moves you like to see out of a company looking for growth.
Is IBM Stock a Buy?
Let’s make a couple of quick blanket observations about IBM. The stock is good for a 5% dividend yield, which is great in a low-yield environment. Shares trade at less than 12 times this year’s earnings, giving us a low valuation. It’s nice to know we’re not overpaying, but we also want to avoid a value trap.
What we are looking for is a stock that has a low valuation, but can see multiple expansion in that valuation. To do so, it needs a catalyst and for IBM stock, this shift could be its catalyst.
There are downsides to IBM, too. Consensus expectations call for a 4% dip in revenue this year and just a 1.6% rebound next year. Next year’s numbers are bound to change because of the spinoff, but that’s how it stood pre-announcement. The same applies to earnings, which are forecast to fall 13% this year and rebound just 10% next year.
We get that fiscal 2020 isn’t going to be a great year or that next quarter isn’t going to be the big change. But we are thinking longer term and looking toward the future.
The company said, “IBM will also have more than 50% of its portfolio in recurring revenues.”
If we can get to the point where IBM is a growing cloud-services company with strong recurring revenue, the stock and valuation will go higher.
The Bottom Line
Is this IBM’s Satya Nadella moment? Nadella was able to turn around one of the largest companies in the world — Microsoft (NASDAQ:MSFT) — and bring it back to relevancy.
This strategic move with IBM will not happen overnight. It will take time to pull off and then set its sights on what its new mission is. That may be why the stock rallied so hard on the day, then gave up about half that rally before the close of trading.
Amid the announcement, IBM also updated investors on its third-quarter results. The top- and bottom-line results were roughly in-line. Earnings matched expectations at $2.58 per share, while revenue of $17.6 billion was slightly ahead of estimates at $17.56 billion.
The growth just isn’t there right now. IBM is a wait-and-see opportunity with its spinoff. However, investors who want to get in early can collect a 5% yield while they wait to see if things shake out in their favor.
New management, a new strategy and a solid dividend can go a long way.
On the date of publication, the author primarily responsible for this article did not hold (either directly or indirectly) any positions in the securities mentioned in this article.