IBM reported a positive surprise in revenue and earnings per share for its 1Q21, an unusual occurrence over the last several years.  Revenue of $17.7 billion was about $300 million ahead of consensus and guidance, the first beat on this metric since 2018.  Gross margins, another trouble spot of late, also came in ahead of expectations. Management reiterated guidance for free cash flow and positive revenue growth for the full year.  At the segment level, these was positive news with improved results across several divisions including continued mid-teens growth at Red Hat, a return to growth for consulting, a gain of over 30% for cloud revenue, and improved but still declining results for transactional software. 

Overall, IBM’s 1Q21 results are a nice confidence boost for Northlake’s investment thesis but the key time frame will be the second half of 2021 when growth should pick up and be more consistent and the company completes its restructuring and the spinoff of a significant portion of its declining legacy revenue base.

We were also encouraged by the company’s conference call following the results.  Given the company’s history over the past decade, the analyst community has a high degree of skepticism.  This often manifests itself in questions that seek to undercut the narrative that IBM is offering with the results.  During this quarter’s call, there were several “gotcha” questions that sought to undercut the good news in the reported results.  Management handled the questions well which has not always been the case in recent quarters.  Encouragingly, the shares traded up after the report but prior to the call, held the gain during the call, and rose further in today’s trading despite a weak market.  The stock price action supports our view that the quarter was a confidence builder.

IBM shares rose from $100 to $130 into the 4Q20 results reported late January only to sink to below $120 when those disappointing results were reported.  The shares had rallied back to $130-$135 into this quarter’s results partially due to the rotation toward value stocks and reopening plays.  At just 12 times 2021 estimated earnings even after the recent run and with exposure to a bounce back in enterprise IT spending as workers return to workplaces, IBM has exposure to both investment themes.

Northlake sees further upside with $160 easily achievable if the company continues to progress on its turnaround plan and returns to the targeted mid-single digit growth target.  Investors are gaining confidence in the company under its still new CEO and results have the potential to build upon the good first quarter.  During the fourth quarter, the company should complete the spin-off of its weakest business units providing another catalyst.  In the meantime, investors are paid to wait by the healthy 4.7% dividend yield.  Management reiterated its support for the dividend and outlined the ease with which it can pay it out of free cash flow.

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.