IBM reported another quarter of encouraging results against our investment thesis highlighted by a return to revenue growth at the best level in three years.  Growth came from the right places driven by Red Hat and consulting services related to cloud initiatives.  Revenue growth of 3% pales in comparison to the cloud leaders including Amazon, Microsoft, and Alphabet.  However, IBM trades at just 11 times 2021 estimated earnings versus the S&P 500 at nearly 20 times.  We have seen dramatic multiple expansion at other legacy tech stocks including Cisco Systems and Oracle as growth showed acceleration.  Northlake believes IBM has returned to growth, albeit modest, and catalysts are ahead to drive multiple expansion and produce above-average returns for shareholders.

While just the first quarter of renewed revenue growth, this is the second consecutive quarter where IBM slightly exceeded Wall Street estimates.  Guidance and management commentary support positive revenue growth in the next few quarters ahead of the planned spinoff of the company’s declining business units.  The new IBM should be able to sustain low to mid-single-digit revenue growth driven by cloud transformation at the many enterprises and governments that still rely on the company.  Management indicated that the transition from legacy hardware and software at long-time customers to cloud-based services is now a net positive for revenue and margins.  Key to the improved outlook is the success of the Red Hat acquisition as indicated by a quadrupling of customers using various IBM hybrid cloud solutions since the deal closed. 

The IBM story has been slower to develop than we expected but recently improved quarterly financial results and the upcoming spinoff should be the start of better shareholder returns.  While we wait, IBM pays a hefty dividend providing an annual return of nearly 5%.  Our target of $160 remains intact with a higher degree of confidence following the good 2Q21 results.  Including the dividend, IBM at $160 would provide a 20% total return at relatively low risk.

IBM is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.