IBM’s Q2 a Tale of Two Drivers; Shares Overvalued

In IBM’s IBM second quarter, the company dealt with continued headwinds to its managed infrastructure business because of the option to now have public cloud providers manage workloads, while also benefiting from cloud tailwinds in its software and business services portfolio. But IBM won’t experience as significant offsetting trends thanks to the cloud in its results for much longer. IBM plans to spin off its managed infrastructure business, which will be called Kyndryl, by the end of this fiscal year. IBM retained its adjusted free cash flow expectations at a midpoint of $11.5 billion for 2021, while refraining from providing a top- and bottom-line outlook. As a result, we’re maintaining our fair value estimate of $125 per share for narrow-moat IBM, which leaves the company overvalued, in our view.

IBM reported revenue of $18.7 billion in the quarter, marking 3% year-over-year growth--the greatest year-over-year growth in 12 quarters. Still, the company had an easy compare due to the COVID-19 pandemic. Nonetheless IBM’s overall cloud revenue continued its growth trajectory, now making up 30% of IBM’s global business services segment and 25% of IBM’s cloud & cognitive software segment, which were also IBM’s two best performing in the segment, without coincidence. The global business services segment grew revenue by 12% year over year and the cloud & cognitive software segment grew revenue by 6% year over year as fast-growing Cloud Paks software is increasing its mix. Systems revenue declined by 7% year over year, significantly impacted by the IBM Z mainframe revenue, which was down 13% year over year due to a tough compare, and in line with typical mainframe cycles. The global financing division continued to suffer the worst performance, with revenue down by 9% year over year, as a result of IBM reducing financing receivables. Global technology services, part of which will be spun off as Kyndryl, had flattish growth when compared with the prior year period.

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