IBM’s Red Hat cloud play is ‘doing fine,’ but analyst sees bigger challenges, Red Hat face copyright infringement, antitrust lawsuit in alleged ‘conspiracy’

RESEARCH TRIANGLE PARK – IBM is playing a game of catch-up when it comes to its focus on hybrid cloud, said Lisa Ellis, senior equity analyst at MoffettNathanson, in an interview with CNBC’s ‘TechCheck’ reporters this week.

“It’s a little bit like trying to turn the Titanic,” Ellis described.  “It’s a very small piece in a much broader portfolio of IBM, much of which is in structural decline and being negatively impacted by the cloud.”

Enterprises are still headed in the direction of private cloud, Ellis noted.

“The challenge that IBM has is that that hybrid cloud portfolio that they’ve got, which is built around the Red Hat acquisition, is just really small,” she said.  “It’s a few billion out of 70, 75 billion of revenue of IBM, so they’ve got this little kernel of a business built around Red Hat that is in hybrid cloud and is doing fine. I would say fine, and not fantastic,”

Because IBM’s products are more software driven, through Red Hat OpenShift, argued Ellis, the company may not necessarily need to be as capital intensive in the construction of big data centers. However, access to available capital is still an important metric for investors to track, she added.

That’s in part because IBM is known to pay what Ellis described as a “healthy dividend” to investors, with the result being that many investors hold the stock in their portfolio because of that anticipated dividend.  Ellis noted that IBM pays about $6 billion in dividends to investors each year.

IBM spinoff Kyndryl outlines global organization, six areas of focus

“Free cash flow is a really, really critical metric for IBM,” said Ellis.  There’s covering the dividend, and there’s also the spinoff of Kyndryl, she argued.  “The real challenge they’ve been having recently, because they’re in the midst of this spinoff of their big data center outsourcing business, they’re taking almost $5 billion in restructuring costs associated with that spin, which is pulling their free cash flows dangerously low,” said Ellis.

“You’re just talking about only having 2 or 3 billion there, right, available for new investments, to try to get this business moving again,” Ellis noted.  “They’re kind of painted into a corner right now.”

Ellis stated in the interview that IBM can’t really execute new investments while also continuing to pay the dividend, given the current availability of capital.  “If their priority is paying the dividend, their flexibility to invest in the business, to try to kind of catch up with the players like Microsoft and Google and Amazon that are way ahead of them in cloud is much more limited.”

In May, an analyst from Bank of America Securities raised the price target for IBM stock to $175 from $153, noting the decision to spin off Kyndryl and to invest in hybrid cloud, and share price surged nearly 3% afterwards.  IBM share price began 2021 at $121.68 and at market close on August 17, 2021, the share price was $142.42, up about 17% year-to-date.  The S&P 500 index is up nearly 20% year-to-date, by comparison.

Unlike the Bank of America Securities analyst, Ellis is more doubtful about the company’s future prospects.

“They’ve been clear their choice is the dividend, but the implication of that is the likelihood they’ll be able to return to meaningful revenue growth is much more limited, this is a business that is just much more likely to kind of tread water, sort of stable modestly declining revenues, and just keep paying the dividend,” she said.

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Anthony Barnett
Anthony is the author of the Science & Technology section of ANH.