Yahoo Finance’s Alexis Christoforous and Brian Sozzi speak with IBM CEO Arvind Krishna about the company’s plans to spin off its legacy business to focus on cloud computing.
BRIAN SOZZI: IBM is ramping up its digital transformation. The company announced this morning that it plans to accelerate its hybrid cloud growth strategy and is also spinning off its managed infrastructure services unit into a separate public company. We have IBM CEO Arvind Krishna here to break down the details. Arvind, good to finally speak with you here. What's the message to Wall Street that you're sending with this portfolio move?
ARVIND KRISHNA: First of all, Brian, it's great to be here, so thank you for having me on. Look, I think today is a landmark day for our company. When I first became CEO I talked about a relentless focus on growth. And when we look at growth, we also said it is going to be a focus on hybrid cloud and AI. That's $1 trillion total addressable market. And given that $1-trillion market and given our confidence in the platform that is based on the Red Hat technologies, now is the time to focus down and double down on hybrid cloud. And that is the first part.
Then there are portions where the client buying needs are changing, so when we look at both applications services and infrastructure managed services, how clients buy those-- of different buyers, different decisions. So that makes sense to spin that off as a separate company. What this does is unlocks growth for both companies. Each can have its own investment models, its own business models. It creates financial flexibility to invest in both companies. Both will have their own partnerships, and so we're so excited. One company focused on hybrid cloud and AI, the second company focused on managed infrastructure services with improved growth trajectories for both companies.
ALEXIS CHRISTOFOROUS: Arvind, you know, Wall Street seems pretty happy with this announcement. Your stock is rallying here. We know this is going to be a tax-free spin off to IBM shareholders expected to be completed by the end of next year. But after the spin off, can you tell us specifically how you plan to grow hybrid cloud, how you plan to take advantage of what you call a $1-trillion hybrid cloud opportunity?
ARVIND KRISHNA: Sure. So, Alexis, if you look at it, you first have to have a hybrid cloud platform that's very attractive to clients. And our hybrid cloud platform is an open hybrid cloud platform based on Red Hat technologies. By the way, we accelerated Red Hat from the low teens of growth to the high teens since we acquired them. So that's the first element of growth.
Then, people don't just take a platform. They also need all the software capabilities to unlock value, whether it's AI, business process management, how do you manage data. And that's the second layer of value. Then many clients need help. They need expertise in their industry to make the journeys towards cloud, and that's where the services component comes in.
By the way, there is a multiplicative dollar effect as you get each of those layers. But then to deconstruct it a different way, Red Hat going from the low teens to the high teens contributes a couple of percentage to overall the remaining IBM's growth. As we invest more, both organically and with acquisitions, into our software business that will create more growth.
We're going to invest in our ecosystem, forming large partnerships. We already announced them-- example, Adobe or Salesforce, Schlumberger, et cetera-- that will contribute the third layer of growth. And finally, as we begin to add more skills, expertise, as well as maybe targeted acquisitions into our services, GBS business, that will create the fourth vector of growth. So you combine the market opportunity, the confidence, and the platform, along with the four vectors of growth I described, and that results in an improved-- much improved trajectory of growth sustainable going forward.
BRIAN SOZZI: Arvind, is part of the message here also to Wall Street that IBM is undervalued? Before this deal, IBM stock traded about nine and 1/2 times forward earnings. But if you look at some of the other cloud players-- you look at Microsoft, about 31 times forward earnings. Is this also you telling Wall Street, you know what? We deserve to trade more on par with our cloud peers?
ARVIND KRISHNA: So, Brian, I'm certainly happy to take that as an outcome. Look, we don't govern the multiple. Wall Street governs the multiple. However, when really look at the elements that go towards it, it is a unit-attractive market. Are you in a market that is growing at double digits? How are you performing in that market? So all those pieces come together.
But Wall Street also tends to value certain businesses better than others. I mean, today we are a majority services business. Going forward about half the business will be software and solutions. So that itself tells you there's a mix change going forward, and those mix changes do come with their own attractive investor base and profile that is in there. And that, by the way, determines the multiple, which as I said is an outcome.
ALEXIS CHRISTOFOROUS: Arvind, your second-quarter cloud revenues were up 30%. Can you give us a window onto perhaps preliminary third-quarter results? How has the business been, especially cloud, through this pandemic?
ARVIND KRISHNA: So, Alexis, I'm not going to comment on third-quarter results because we're still closing the books and all that. We did put out just a revenue and an EPS number, so that's all we're going to comment on at this time.
But look, overall, as we can see, clients are accelerating their digital journeys. And I think the pandemic of the last, to now, seven-- nine months has clearly accelerated all of that with all our clients. I've been on the record saying what used to take five years is likely going to take two. And if that's the kind of acceleration that's happening, we-- you're going to see cloud acceleration happening.
But cloud is not just public cloud. It includes hybrid cloud, which is inclusive of what they do with the current infrastructure as a private cloud, multiple public clouds, SaaS properties and how do they embrace all of those, get productivity from their employees, but also get highly, highly resilient. I think people are focused on cost savings, but that's not the primary driver. The primary driver really is digitization and how they can get all the way through those transformations. And that's the opportunity that we are going to be able to tap into with this move.
BRIAN SOZZI: Arvind, last one before we let you go. The revenue growth rate did improve, about down 2.2% in the preliminary results you just provided. Second quarter down about 5 and 1/2%. how would you grade client spending confidence? Just looking at that number, it seems to have improved.
ARVIND KRISHNA: I think that-- look. I think that we haven't even looked at the early days in March, April. We saw a lot of people move towards what I call survival mode. So they were all worrying about cash conservation. We saw a number of transformational projects kind of pause. We saw client volumes in many cases begin to come down.
Then as people began to realize this is not a two- or three- or four- or five-month pause, this is going to perhaps be longer. Then you saw people take a different tack. Well, if I have to do a transformation, let me do the correct transformation all the way forward. So we are seeing a number of large transformational projects not come back up but of a different ilk than before.
Always, I mean, people always want cost savings, but I don't think it's priority number one anymore. It's one of the priorities that's in there. But I think getting to the correct end point, leveraging hybrid cloud, leveraging AI to unlock value from data, making sure that you're cyber secure as all the employees work from home, making sure people are productive in this new environment-- those are more the priorities we are seeing, Brian, and we're seeing those play out when we look at our signings, when we look at our book of business.