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IBM's Cloud Computing Holds Major Potential: Should You Buy?

Zacks Equity Research

International Business Machines Corp.’s IBM investor briefing last month reflected its continuing focus on being a cloud-first company. In 2016, cloud revenues grew 35% to $13.7 billion, while the annual exit run rate for cloud-as-a-service revenue increased 53% on a year-over-year basis to $8.6 billion.

In its latest quarterly earnings report, the tech giant reported cloud segmental revenue growth of 45% from the prior-year period. Additionally, IBM has over 50 cloud centers globally, and its Bluemix platform was one of the largest open public cloud deployments worldwide at the end of 2016.

IBM’s Watson on Cloud is also a key growth driver for the company. The company expects Watson to reach over 1 billion people by the end of 2017, and IBM estimates the market for Watson on Cloud as a decision-making support system to be worth nearly $2 trillion by 2025.

Cloud Computing: Robust Growth Expectations

IBM’s growth expectations from cloud computing remain positive in the long haul. Management anticipates market opportunity in enterprise cloud to be greater than $800 billion by 2020. Moreover, the company expects more than 85% of enterprises to commit to multi-cloud architectures by 2018, which is positive for its hybrid cloud offerings.

The overall growth expectation for the public cloud computing services market is very bullish. According to Gartner, the worldwide public cloud services market was projected to grow 18% through 2016 to $246.8 billion in 2017. This figure will increase to $383.3 billion by 2020.

Infrastructure-as-a-Service (IaaS) is projected to be the highest growth service driven by improvement in platform-as-a-service (PaaS) and massive adoption of artificial intelligence (AI), analytics and the Internet of Things (IoT). IaaS is projected to grow from $25.29 billion in 2016 to $71.55 billion in 2020.

IBM Lags Behind in the Cloud

Despite impressive growth figures and bullish sentiments, IBM lags behind the likes of Amazon AMZN and Microsoft MSFT in the public PaaS and IaaS cloud computing markets. According to Synergy Research’s latest report, Amazon Web Services (AWS) maintained its dominant position in the market followed by Microsoft’s Azure, Alphabet’s GOOGL Google, and IBM at the end of fourth-quarter 2016.

The research firm noted that these three have gained market share in the last one year at the expense of smaller players, as well as strong growth from both Microsoft and Google. However, their combined market share of 23% lags compared with Amazon’s 40%.

We believe that IBM’s hybrid approach has yet to find many takers in both the public and private cloud markets. Despite significant investments – first on acquiring SoftLayer for $2 billion and then spending more than $1 billion on data centers – its client list is not as impressive as Amazon’s or Microsoft’s.

China: IBM’s Savior?

Per Gartner, China has become a significant IaaS cloud market. The research firm noted that “While China's cloud service market is nascent and several years behind the U.S. and European markets, it is expected to maintain high levels of growth as digital transformation becomes more mainstream over the next five years.”

IBM is now planning to tap into China’s fast-growing cloud computing market through a new company formed in collaboration with Wanda Internet Technology Group. The new company will offer IaaS and PaaS to Chinese businesses. Reportedly, IBM will have a share in revenues.

Moreover, as a part of the deal, the company will launch Watson services to China. IBM is expected to offer Watson Conversation services, which will allow developers to add natural language interactions between clients and applications.

Bottom Line

In its Q1 earnings report, IBM reported a bigger-than-expected drop in revenue, marking the 20th consecutive quarterly sales decline. Demand for its legacy hardware and software businesses is stagnating, but IBM has been slowly shifting towards cloud-based areas over the years.

Despite lagging behind in comparison to its competition, IBM is developing a niche for its hybrid cloud services, along with “Strategic Imperatives” like cognitive computing, artificial intelligence, and machine learning. And with Watson, IBM is advancing in vital areas like Internet of Things, healthcare, and financial services end-markets that will support growth in the long run.

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