IBM bullish on hybrid cloud; sees short-term challenges and long-term opportunities

The first six months of the fiscal year were challenging for IBM Corp. (NYSE: IBM) but the tech giant’s performance has been stable as its top customers were not materially affected by the virus attack. But low demand from tier-two customers, who shifted focus to preserving liquidity and cost-reduction, had a negative impact on the business.

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If the virus-linked slowdown lasts longer than initially expected, as some experts warn, IBM’s revenue will remain under pressure after declining in the first two quarters of fiscal 2020. In general, the tech sector is looking at short-term headwinds and long-term opportunities. IBM bets on its strong fundamentals, compelling pipeline, and stable business model to tide over the challenges. Statistics show that only 20% of enterprise workload has been shifted to cloud and the remaining 80% remains untapped.

Interacting with analysts at his second earnings conference call as IBM’s CEO, Arvind Krishna said, “We’re going to continue to invest in our business and we have the right liquidity, the strength of our balance sheet and investment in thin flex profile to take the right actions in this environment to advance our strategic priorities going forward.”

Hybrid Cloud

The Big Blue is bullish about hybrid cloud, considering the growing relevance of the technology in the evolving market that continues to witness mass cloud migration. It is believed that businesses would prefer the hybrid format – a combination of public, private, and on-premise environments – for the additional value it offers. The recent acquisition of Spanugo, a cybersecurity expert for hybrid cloud, and AI technology firm WDG Automation is expected to catalyze IBM’s hybrid push.

On the server front, Red Hat is making strong contributions to revenue and booking growth, reflecting the stable demand for its products. Meanwhile, the mixed outlook – anticipating further project delays, volume reduction, and spending cuts by clients – has hampered the management’s visibility into the future. The uncertainty calls for caution as far as investing in IBM is concerned, which is underlined by the mediocre target price and moderate buy rating on the stock.

Rightsizing

The company managed to end the second quarter with an impressive gross margin and cash balance and reaffirmed its resolve to return value to shareholders. Being a market leader doesn’t stop IBM from changing its operating model to adapt to the changing business environment. Ensuring a balanced client-portfolio mix would be the key to achieving total operational improvement.

Around 70% of IBM’s revenue comes from large clients which have not been materially affected by the pandemic. On the flip side, it laid off hundreds of employees in recent weeks as part of realigning the cost structure. While the management has withheld the details, as usual, speculation is rife about the scale of workforce reduction. 

“What’s most important to me and to IBM is that we emerge stronger from this environment, with a business positioned for growth. And I’m confident we can do that. My focus will be on investing and maintaining flexibility to take action not just to strengthen our operating model, but also to advance our strategic priorities.”

IBM’s CEO Arvind Krishna

Neat Q2 Outcome

Earnings contracted by a third to $2.18 per share, year-over-year, in the second quarter but surpassed the consensus estimate, continuing the long-term trend. A 3% growth in the cloud segment, which includes contributions from Red Hat that joined the IBM fold a year ago, was insufficient to lift the top-line. Revenues dropped 5% annually to $18.1 billion, hurt by weakness in the Technology Services and Business Services segments. It was the second consecutive fall and the weakness was spread across all geographical regions.

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For more insights about IBM, read the latest earnings transcript here.

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Investors responded positively to the stronger-than-expected results and IBM’s shares made strong gains this week, extending the post-selloff rebound that started in mid-march. Unlike some of its peers, the tech firm is recovering at a sluggish pace, underperforming the market. The shares have lost 15% in the past twelve months.