Project Description

IBM Infrastructure Spin-off Notes

10/15/2020 Update

10/9/2020 Update

  • Spin-off:
    • Technology services division. Has struggled for years:

    • Spin-off will be lower growth and lower margin but will have an investment grade credit rating.
    • Will compete against DXC Technologies (DXC), Microsoft (MSFT), and BMC Software (private).
    • Company has relationships with 4,600 clients in 115 countries and 90,000 employees.
    • Operates in $500BN market.
    • New company will be able to partner with all cloud vendors instead of just IBM (although it will remains IBM’s preferred partner), should provide an opportunity for growth.
    • Timing: expected to be complete by Q4 2021.
    • Opted for a spin-off to provide customers with certainty over next steps. IBM would be open to an acquisition offer as long as it didn’t jeopardize customer relationships.
    • Leadership structure will be decided within a few months.
    • Will be twice the size of its nearest competitor.
    • Will focus on operational efficiency and cash generation.
    • In the most recent quarter, global technology services (the division that encompasses managed infrastructure services) saw revenue decline by 7.6% y/y.
  • Over the past fifteen years, IBM has taken several initiatives to change strategic focus for the company.
    • It sold its PC manufacturing business to Lenovo Group in 2005 (IBM was losing share to Dell)
    • In 2014, it exited its semiconductor business (IBM had to pay Global Foundries $1.5BN to take its division off its hands!)
  • Nonetheless, IBM has struggled to reposition the company.
    • Over past 8 years sales have declined by 25%.
    • IBM was late to the cloud and trails Microsoft and Amazon considerably.

      • IBM has tried to focus on the hybrid cloud where clients use to manage software and other systems across different cloud services and their own data centers.
      • In 2019, IBM bought Red Hat for $34BN largely to catch up in cloud computing.
      • Once spin-off is complete, more than 50% of revenue will be recurring.
      • Remainco is expected to grow mid single digit growth in the medium term.
      • Since Red Hat acquisition cloud revenue growth has accelerated. In Q2 2019, cloud grew 5%. In Q2 2020, cloud revenue grew 30%.  IBM has succeeded by focusing on the hybrid cloud market which it calls a $1 trillion opportunity.
  • Why is the cloud?
    • Companies rent rather than buy computing horsepower.
  • Decision was made by new CEO (became CEO in April 2020), Arvind Krishna.
    • Before becoming CEO, Krishna ran the company’s cloud and cognitive-software division.
  • Layoffs
    • In the backdrop of the pandemic, IBM announced that it would be laying off an unspecified number of workers as customers dial back IT spending and software spending on new deals.
  • Dividend:
    • Committed to sustainable and growing dividend.
    • IBM is a Dividend Aristocrat as it has 25 years of dividend increases.
  • Debt:
    • The company has $58.4BN of debt. Net debt to EBITDA is 4.4x. Pretty significant. Both companies will have an investment grade rating after the transaction.
  • My initial thoughts:
    • Usually it doesn’t pay to invest in businesses that are in secular decline which it appears the spin-off is. However, I bet it will pay a pretty sizeable dividend and this might provide a measure of downside support.
    • IBM stock popped 6% on the announcement. This is typical of companies that announce spin-offs, but over time, I would expect the stock to fade as “spin-off euphoria” dissipates.
    • The announcement is a positive for IBM shareholders, but not necessarily a reason to buy the stock today.
    • We have a lot of time to wait. Transaction won’t take place until the end of 2021.