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IBM's fortunes set to rise in 2021 on hybrid cloud, IT infrastructure spinoff

International Business Machines Corp.'s decision to double down on cloud computing and spin off its less-profitable IT infrastructure unit will prove to be highly beneficial for the company in the long run, analysts said.

IBM beat Wall Street estimates for the first quarter with a return to year-over-year revenue growth that was primarily driven by its cloud offerings. The company also forecast a return to pre-pandemic levels of growth in the second quarter and through the rest of the year, which would reverse a four-quarter streak of declining revenue throughout 2020.

Despite last year's consolidated revenue declines, however, IBM's cloud units proved to be more resilient during the pandemic, with sales for offerings such as Red Hat, the open-source software firm IBM acquired in July 2019, continuing to grow.

The cloud continued to pay off for IBM in the just-ended first quarter of 2021. Total cloud revenue, which draws from various business units, grew 21% to $6.5 billion in the period, while the cloud and cognitive software segment, which includes Red Hat, was up 3.8% to $5.44 billion.

IBM's global business services and systems segments also surprised in the quarter, with year-over-year revenue growth of 2.4% and 4.3%, respectively. Overall, the company reported consolidated revenue growth of 1% year over year to $17.73 billion, in its first overall growth quarter since late 2019.

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"It was good to see IBM get back to growth after a year and even better to see the company beat the Street on revenue and earnings," said Patrick Moorhead, president and principal analyst at technology research firm Moor Insights & Strategy. "What you would want to be up, cloud and cognitive, were up, and I was thrilled to see systems and global business services growth as it wasn't expected."

Moorhead said it was harder for IBM to weather the COVID-19 storm compared to other major tech firms because the company does not have many major software-as-a-service offerings. This type of software saw usage explode during the pandemic.

IBM said it expects to grow revenue for full year 2021. The S&P Capital IQ consensus estimate is about $18.31 billion for the company's second-quarter revenue and $74.35 billion for the full year.

Following the better-than-expected earnings results and guidance, IBM's stock, which closed at $133.12 on April 19, surged nearly 5% in after-market trading. The stock has continued to climb as several equity analysts raised their price targets. It was trading at $143.48 near the closing bell April 21.

Credit Suisse analyst Matthew Cabral called IBM's first quarter a "much-needed bounce back" and commended the company's continued focus on the hybrid cloud — a cloud computing environment that uses a mix of on-premises, private cloud and third-party, public cloud services with orchestration between these platforms.

"Red Hat is a strategic win in a hybrid-first world," Cabral wrote in his analyst note to clients. "We firmly believe hybrid is the steady-state equilibrium for enterprise IT."

Cabral also said the separation of IBM's Managed Infrastructure Services business, which is expected to be complete in the fourth quarter, will be a key catalyst in sustaining revenue growth for the company.

Argus Research analyst Jim Kelleher, who reiterated his "buy" rating and $155 price target on IBM's stock, also highlighted the forthcoming spinoff as a primary growth factor for the company's financial performance this year.

"Mainly, the new company houses lower-margined and slow-growth businesses and hiving them off from the core company should help IBM become a faster-growing and higher-margined entity," Kelleher said. "While investors have been frustrated at the slow pace of progress, we believe the spin-off will unlock margin expansion, while the return to a more normal post-pandemic economy will stimulate IBM's hybrid cloud growth."

Meanwhile, UBS analyst David Vogt said while IBM's revenue and EPS topped forecasts, the company's software results still showed softness in its key cloud-computing segment.

"We expect IBM shares to trade sideways as investors await completion of the spin-off expected by year-end, as IBM's cloud and cognitive revenue again came in below our forecast, consistent with recent results," Vogt wrote in his latest analyst note.

Nevertheless, Vogt raised his price target on IBM's stock to $126 from $122 and maintained his "neutral" rating.