Information Technology giant, International Business Machines Corp. (IBM) is set to boost its cloud computing ambitions with the launch of its new computing service “Smart Cloud”.
Smart Cloud offers cost-effective data analysis, supply chain management and sales management capabilities to big companies that incur significant IT costs related to these operations. The Smart Cloud would enable the companies to store their data on IBM’s servers and access it securely over the Internet.
IBM’s sales pitch is focused on security and reliability, since the tech behemoth will be allowing the companies to configure resources to suit their own requirements for security, government compliance and backup.
According to IBM, the Smart Cloud will enable it to differentiate its cloud services from the usage-based resources currently offered by its rivals Amazon Inc. (AMZN), Microsoft Corp. (MSFT) and Google Inc. (GOOG). We tend to agree, since the services provided by these companies are more general in nature, while IBM’s services are targeted at big companies with sprawling operations that have so far stepped back from the cloud on security and governance concerns.
The Smart Cloud is compatible with various hardware and operating systems such as Linux, Windows, IBM’s AIX and Oracle Corp.’s (ORCL) Solaris system.
Companies deciding to transfer operations to the Smart Cloud would be able to choose storage computers from IBM and EMC Corp. (EMC) and would have access to a variety of databases including Oracle’s and business applications from SAP AG (SAP).
The Smart Cloud is a step in the right direction and we expect it to drive IBM’s growth in the cloud computing market. IBM intends to generate revenues of $7.0 billion (more than 5.0% of the total revenue) from cloud computing by 2015.
IBM is expected to offer the Smart Cloud app to its existing cloud computing customers such as Lockheed Martin Corp. (LMT), Macy’s Inc., ING Groep N.V. and Kaiser Permanente.
A little background – Cloud Infrastructure as a service (IaaS) is an emerging business, according to research firm Gartner Inc. The market is expected to grow from an estimated $3.7 billion in 2011 to $10.5 billion by 2014. Through the Smart Cloud, IBM is well positioned to take advantage of this strong growth in our view.
We believe Smart Cloud’s compatibility with the leading operating systems and databases will boost IBM’s customer base and will also drive higher hardware and software sales over the long term.
Although IBM possesses massive data centers, analysts believe that the company will face tough competition from Amazon Web Services and Microsoft’s Windows Azure going forward.
Moreover, entry of large IT companies such as Hewlett Packard Co. (HPQ) in the cloud computing market will also be a headwind for IBM over the long term.
Further, consolidation in the cloud computing market (larger companies buying a smaller but successful cloud computing company) is expected to affect IBM going forward.
2015 Guidance
IBM has identified cloud computing as one of the key growth drivers along with business analytics, sales in emerging markets and the Smarter Planet initiative. These are expected to contribute approximately $20.0 billion in revenue growth by 2015.
IBM expects to earn revenues of $50.0 billion by 2015, driven by base revenue growth of 2.0%, 1.0% from a shift to faster growing business mix and 2.0% from acquisitions.
Sales from emerging markets are expected to contribute 50.0% of total revenue growth in 2015, growing from a 21% revenue share in 2010 to a 30% share over the next five years. IBM expects business analytics to contribute 20.0% of growth by 2015.
The company expects to spend $20.0 billion in acquisitions, particularly companies with higher growth intellectual property (IP) that are in sync with IBM’s global reach, scale and business model.
IBM expects to continue its investment on higher value businesses, and will increase research & development (R&D) spending by $35.0 billion in the next 5 years. The company expects to incur productivity savings of $8.0 billion over the next 5 years.
All this should result in significant margin expansion by 2015, with higher-margin software contributing 50.0% to the growth. IBM expects to achieve earnings of approximately $20.00 per share by 2015.
The company expects to generate $100.0 billion of free cash flow over the next 5 years, of which $70 billion will be returned to IBM shareholders in the form of share buyback and dividends.
Recommendation
We remain optimistic on the company’s long-term growth following the bullish outlook provided by management. Strong service backlog, diversified product pipeline, higher growth from outsourcing and business analytics will cumulatively boost top-line growth going forward.
We also believe that IBM’s growing initiatives in the smarter planet, business analytics and optimization and cloud computing areas will drive long-term growth. Besides, the ability to generate strong free cash flow, expand margins and improve the already robust balance sheet make the stock attractive over the long term.
On the flip side, currency fluctuations, decreasing contract signings and increasing competition remain the primary headwinds. We have a long-term Neutral recommendation on the stock.
Currently, IBM retains a Zacks #3 Rank, which implies a short-term Hold rating.
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