This week, International Business Machines (NYSE: IBM) posted surprising year-over-year revenue growth in the first quarter. Investors shouldn’t be too excited, however. Big Blue’s top performance was not that impressive and management did not upgrade their outlook for the full year. However, thanks to its modest valuation as part of its transition to the cloud, IBM remains an attractive investment opportunity.
Contrasting high-end performance
IBM’s first-quarter revenue grew 1% year-over-year to $ 17.7 billion – the strongest revenue growth for the company since the second quarter of 2018. Admittedly, this result is derisory compared to the spectacular performances of certain specialists of the technology in recent years. quarters. But that is an encouraging improvement from the 1.5% year-over-year drop in revenue to $ 17.3 billion that analysts had expected.
However, investors should not be too excited about this positive result for several reasons.
First, through its international presence, IBM has benefited from favorable exchange rates. At constant exchange rates, sales were down 2% year over year.
Second, when calling the results, CFO Jim Kavanaugh said the unexpected good results from the mainframe business, up 49% year-over-year at constant exchange rates, amounted to a few hundred million dollars in additional revenue. Indeed, increasing demand for IBM’s z15 mainframe is a positive development, but it is not a sustainable source of revenue growth given the cyclical nature of this business.
Finally, despite the surprising revenue performance, management did not update their outlook for the full year, suggesting that better than expected revenue growth in the first quarter was not a sign early long-term improvement in business prospects. Consistent with the prior quarter, management expects annual revenue growth year over year (without giving further details) and free cash flow adjusted to land between $ 11 billion and $ 12 billion.
Vast cloud opportunities
Beyond the company’s quarterly performance, IBM remains a bet on its transition to cloud computing and artificial intelligence (AI). Since its acquisition of Red Hat for $ 34 billion in 2019, IBM’s cloud business has generated strong double-digit growth that contrasts with the decline in the company’s traditional business.
In the first quarter, cloud business revenue grew 21% year-over-year to $ 6.5 billion, confirming the success of the company’s focus on solutions allowing applications to run on any combination of private and public cloud (hybrid cloud) thanks to its flagship product. OpenShift product.
Certainly, IBM will face strong and growing competition in the field of hybrid cloud, as illustrated by Microsoftrecent efforts by the company to provide management solutions for hybrid clouds with its Azure Arc offering. But the enormous size of this market leaves plenty of room for Big Blue – and its competitors – to continue to generate strong double-digit revenue growth over the next several years.
And to capture some of this great management opportunity estimated at $ 1 trillion, IBM has created partnerships that leverage its hybrid cloud solutions and consulting business. For example, during the last quarter he joined forces with the big data specialist Palantir Technologies to facilitate the deployment of Palantir’s data analytics capabilities on hybrid clouds.
An attractive bet
So, despite IBM’s poor performance in the first quarter, investing in the company still offers attractive exposure to cloud computing and AI.
Indeed, IBM’s market capitalization is only 10.7 times the mid-range of the adjusted free cash flow expected by management for the full year. However, you should take this year’s Adjusted Free Cash Flow with a grain of salt. The company will record a cash charge of $ 3 billion (excluded from adjusted free cash flow) to fund its transformation, which includes the separation of its legacy managed infrastructure business it announced in October.
But beyond the short term, executives expect cloud and AI initiatives to continue to support revenue growth. And adjusted free cash flow is expected to increase to a range of $ 12 billion to $ 13 billion in 2022.
So while IBM’s surprising first quarter revenue growth didn’t excite me, I’m still happy to own my shares given the low valuation of the company against the backdrop of modest revenue growth. long term and free cash flow.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.