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Wednesday, February 8, 2023

Why Planned Split Makes IBM Stock More Attractive to Growth Investors

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Six months into the reign of a new CEO, IBM (NYSE:IBM) stock is unattractive to growth investors for the simple reason that the company hasn’t been growing. In that time, IBM stock has lost 6.7% while the broader S&P 500 index has gained 9.4%.

Sign of IBM with Canada Head Office Building in background in Markham, Ontario, Canada. IBM is an American multinational technology company.

Source: JHVEPhoto / Shutterstock.com

The tech giant’s revenue was nearly $80 billion in 2015; last year, its top line came in at $78.2 billion. But the spin off of the company’s managed services business, announced on Oct. 8, will change that dynamic.

Can IBM Stock Regain High-Growth Status?

After the spin off, IBM, which will “ focus on its open hybrid cloud and AI solutions,” will likely grow rapidly. That’s because, as I noted in a previous column, the “revenue of IBM’s hybrid cloud unit soared 34% year-over-year last quarter, up from 23% in Q1.” And of course, companies’ utilization of AI has been surging tremendously.

As the Street internalizes the idea that IBM stock will become a growth name and a cloud-focused company following the split, the shares should climb meaningfully.

Further, if IBM’s new CEO, Arvind Krishna, and its new president, Jim Whitehurst, can accelerate the growth of IBM’s cloud unit in the coming quarters, investors will start to become more excited about the upcoming spin off, causing the shares to spike.

I believe that this scenario is likely to play out, as the integration of Red Hat into IBM continues. Moreover, as I pointed out in a previous column, Krishna and Whitehurst are both very well-versed in cloud technology. Specifically, in my Feb. 25 column, I noted that:

“Krishna, who had been the company’s senior vice president for cloud and cognitive software, is a cloud and technology expert who has built IBM’s cloud unit into a formidable player in the sector. Meanwhile, Whitehurst, the longtime head of Red Hat, turned that company into a highly successful technology firm, showing that he has tremendous management and marketing abilities. “

Additionally, following the spinoff, both executives will be able to focus primarily on growing the company’s hybrid cloud business.

The hybrid cloud market is huge and growing rapidly; according to one independent estimate, the market will surge from $44.6 billion in 2018 to $97.6 billion by 2023, at a compound annual growth rate (CAGR) of 17.0% during the forecast period.

Spin-Off Will Have Its Own Attractions

The company that will be spun off (IBM refers to it as NewCo) will focus on managed infrastructure. Since the technology of the managed infrastructure unit, which includes “servers and storage,” is generally not changing as quickly as that of the cloud, NewCo will not not have to spend very much on R&D or acquisitions.

Indeed, IBM said that NewCo’s focus will be “operational efficiency and cash flow generation.” As a consequence, I expect NewCo to pay a high dividend and have an extremely elevated dividend yield, attracting many income investors.

Given the fact that NewCo will have a backlog of $60 billion and serve more than “75% of the Fortune 100” companies, while possessing an investment-grade credit rating, income investors will feel very comfortable owning its shares.

Finally, NewCo will presumably receive IBM’s server business, which, as I noted in a previous column, generated revenue growth of 17.6% last quarter after launching a new, beefed-up processor last year.

Analysts Upbeat on Spinoff

Wedbush analyst Moshe Katri told Reuters that, “IBM is essentially getting rid of a shrinking, low-margin operation given the cannibalizing impact of automation and cloud, masking stronger growth for the rest of the operation.”

Meanwhile, calling the spinoff “a bold move,” Morgan Stanley analyst Katy Huberty raised her price target on IBM stock to $140 from $126, although she kept an “equal weight” rating on the shares. Huberty explained that she thinks the spin off is “”just the first step to sustained growth.”

Over the medium-term, the spinoff should make investors more bullish on the shares. In the longer term, the owners of the shares will get access to a high-growth, high-multiple company and a good dividend stock. With IBM stock still trading at just 10.8 times its forward earnings, investors should buy the shares.

On the date of publication, Larry Ramer did not have (either directly or indirectly) any positions in the securities mentioned in this article. 

Larry has conducted research and written articles on U.S. stocks for 13 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Among his highly successful contrarian picks have been solar stocks, Roku, Plug Power, and Snap. You can reach him on StockTwits at @larryramer. Larry began writing columns for InvestorPlace in 2015.

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