IBM’s Spinoff and Restructuring Plans Look Like Steps in the Right Direction

As a long-time critic of the company, I’ll be the first to say that IBM (IBM) still faces its share of competitive and secular pressures. But the planned spinoff of Big Blue’s managed IT infrastructure services business is encouraging news.

First, the managed infrastructure business — though said by IBM to have a $60 billion-plus backlog and more than twice the scale of its nearest rival — is clearly struggling. IBM’s “infrastructure & cloud services” revenue, which is reported within its Global Technology Services (GTS) segment, was down 7% annually in Q2, 6% in Q1 and 5% in Q4. And this is in spite of the fact that this revenue also covers the IBM Cloud public cloud services unit, which appears to be growing.

Secular headwinds — specifically, the adoption of cloud infrastructure platforms much larger than IBM’s, such as AWS and Microsoft Azure — are clearly a factor here. But growth comparisons suggest GTS has also been losing share to rivals such as Accenture (ACN) and Wipro (WIT) . A spinoff that leaves IBM’s managed infrastructure business in the hands of a management team that’s focused solely on running that business just might help turn things around.

Meanwhile, shedding the managed infrastructure business allows new CEO Arvind Krishna and other IBM execs to direct more of their attention towards value-added software, hardware and services offerings. And from the looks of things, that’s what they generally want to do.

Quite a few IBM businesses are seeing revenue declines right now. Source: IBM.

To be sure, the IBM press release announcing the spinoff still contains a lot of the usual Big Blue marketing-speak. Though IBM might now claim to be focused on “its open hybrid cloud platform and AI capabilities,” many of the businesses that aren’t being spun off have nothing to do with either the cloud or (regardless of how this nebulous term is defined) “AI”. Quite a lot of IBM’s business — from mainframes and storage, to middleware and transaction processing software, to consulting and software outsourcing services — will still involve on-premise IT environments.

But at the same time, Krishna did stress on a Thursday conference call that he wants IBM to invest more in businesses such as recently-acquired Red Hat (a clear bright spot right now) and app modernization services, as well as in partnerships with the likes of Adobe (ADBE) and (CRM) . And he outlined plans for a restructuring that aims to simplify IBM’s geographic model and overhaul its go-to-market efforts, in order to make the company more nimble.

Such actions are far from a cure-all, and (though current tech valuations make this difficult) they might need to be complemented by another meaningful acquisition or two that targets growth markets. But such moves do suggest Krishna has some understanding of the kinds of changes that are needed if IBM is going to hit its “medium-term” target of mid-single digit organic growth, after many years of largely failing to achieve such growth.

And as far as investors are concerned, it’s hard to overlook the fact that — with shares trading below their 2012 highs, even after adjusting for dividends and accounting for IBM’s 6% Thursday gain — IBM’s stock isn’t exactly pricing in a lot of future growth right now.

IBM’s current $145 billion enterprise value is equal to just 12 times its 2019 free cash flow (FCF) of $11.9 billion — FCF, it should be noted, that’s far below a 2012 peak of $18.2 billion. If the company does actually manage to achieve mid-single digit organic growth, and somewhat higher EPS and FCF/share growth with the help of margin growth, operating leverage and buybacks, that looks like a fairly reasonable valuation.

That’s a big if of course, particularly given how much IBM has burned so many value investors over the years. But with the company at least doing one or two things right at this moment following a leadership change, bargain-hunters might want to keep it on their radar.

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