Tech giant International Business Machines (IBM -1.99%) doesn't seem like an agile and innovative company primed to outperform the fast-moving tech industry. IBM's large scale and long history magnify the market's doubts about the company's ability to become a growth story. But Wall Street doesn't realize yet just how much IBM is actually poised to drive technological shifts – and its own future expansion.
Shift to the cloud
There are many reasons to view IBM as a shrinking old-tech company. After several years of decline, trailing-12-month revenue dropped to $79.6 billion compared to a peak of $106.9 billion in 2011. The 108-year-old company has been struggling with hardware-related businesses and has divested some of these legacy activities. For instance, the Intel-based server business IBM sold to Lenovo in 2014 represented $4.6 billion of revenue the previous year. Employee headcount shrank from an average 433,362 in 2011 to 350,600 in 2018, another sign of a declining company.
But IBM is transitioning to growth areas, and the shift to cloud computing is a significant part of this strategy. IBM's cloud trailing-12-month revenue of $19.5 billion grew 8% year over year. And the acquisition of Red Hat will contribute to the expansion of its cloud businesses, which represented roughly 25% of IBM's revenue over the last 12 months. This evolution has also fattened margins: Pre-tax income margin increased to 16.6% during the last quarter compared to 15.9% two years ago.
As a result, management forecasted mid-single-digit revenue growth over the next couple of years. And given IBM's operating leverage, operating income is expected to grow at a faster pace.
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IBM's potential to become a disruptive high-tech company
IBM's capacity to adapt and keep up with the evolution of technologies goes beyond its cloud-based initiatives, though.
For many years, the company has been holding the top position in the list of the number of granted U.S. patents. In 2018, IBM filed more patents (9,100) than the next two companies combined (5,850 and 3,056). Besides, IBM processors equip the two most powerful computers in the world, according to top500.org, and a third IBM supercomputer made it to the top 10.
These technological achievements don't translate into immediate earnings. But they show the capability of the company to innovate and propose performant solutions. Besides, IBM has the potential to become again a disruptive company.
For instance, over the last few years, IBM launched several initiatives around blockchain technology such as its food safety blockchain and its payment system. The Food & Drug Administration recently selected IBM to develop a blockchain-based pilot program for real-time monitoring of drug supply chains. And IBM has already developed worldwide and commercial blockchain applications, such as its co-project with Maersk, TradeLens. Many companies like Overstock.com with its Medici Ventures and Facebook with its Libra initiative are developing blockchain technologies, but none of them reached IBM's worldwide scale and commercial status.
Besides, the quantum computing technology IBM is developing doesn't get as much attention as Alphabet's moonshot projects about self-driving cars and delivery drones. But investors should also consider the disruptive aspect of IBM's quantum computing technology and its potentially huge leap in computational power.
The market ignores IBM's growth potential
Despite IBM shares' 25.8% increase since the beginning of the year, the company's modest trailing-12-month P/E ratio of 14.8, based on the trailing-12-month earnings, indicates the market doesn't expect any growth.
But investors should look beyond the weak results IBM reported over the last several years. Growth from the company's cloud businesses will become obvious during the next couple of years. And IBM's investments in disruptive technologies like blockchain and quantum computing constitute extra long-term opportunities.
