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Can chameleon Big Blue change its colours?
IBM is renowned for reinventing itself. It now plans to spin out its Global Technology Services business, a division that was once its crown jewels
In 2011, as IBM celebrated its 100th anniversary, Sam Palmisano stepped down as its chairman and Ginni Rometty took over as chairman, president and CEO. Palmisano wrote: “This is a fundamentally different IBM than existed a decade ago – one that is delivering historic results despite a global economic downturn, even as it more fully exemplifies the company’s century-old character.”
Less than a decade later, while Rometty remains chairman, Arvind Krishna is now CEO, the company has spent $34bn acquiring Red Hat to bolster its cloud offerings, and is now spinning off its IT services arm.
According to IBM Corporate Archives, in 1991 the company was a $64.8bn business, with less than $6bn of its revenue coming from non-maintenance services. The Global Services business was formed in 1995.
Interestingly, the initial idea to develop an IT services business for its customers began with a datacentre contract with Kodak-Eastman in 1989. By the start of 2000, IBM’s Global Services business generated more than 40% of the company’s $86bn annual revenue.
Earlier this month, the company announced that it would be split in two, with the current incarnation of this services business, Global Technology Services (GTS), operating as a separately listed company.
IBM said the spin-off, dubbed “NewCo”, would be entirely focused on managing and modernising client-owned infrastructures – a $500bn market opportunity. As a services-led business, it aims to offer hosting and network services, services management, infrastructure modernisation, and migrating and managing multicloud environments. IBM said NewCo’s services would enable enterprises to build agility and efficiency into their infrastructure and datacentres.
Rometty commented: “Our managed infrastructure services business has established itself as the industry leader, with unrivalled expertise in complex and mission-critical infrastructure work. As two independent companies, IBM and NewCo will capitalise on their respective strengths. IBM will accelerate clients’ digital transformation journeys, and NewCo will accelerate clients’ infrastructure modernisation efforts.”
Through the split, said IBM, NewCo will increase investment in the next generation of transformational managed infrastructure services, with more opportunity for margin expansion, profit growth and cash generation. Being run as a separate entity to IBM means it will also be able to partner across all cloud suppliers, which IBM said would open new avenues for growth.
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IBM’s GTS has been struggling as a business. During the earnings call for its second-quarter 2020 results, IBM’s chief financial officer (CFO), Jim Kavanaugh, reported that GTS revenue had declined by 5%. In a transcript of the earnings call posted on the Seeking Alpha financial blogging site, he discussed how the coronavirus pandemic had affected the business.
“While this business has a high mix of recurring revenues, there is some variability in that revenue stream,” he said. “We provide clients with flexibility in their capacity to deal with volume changes due to their business needs and macroeconomic environment. As the pandemic intensified through the end of March and into the second quarter, we experienced lower client-based business volumes, reflecting challenges across industries.”
Forrester principal analyst Ted Schadler said: “Infrastructure services has been a declining-margin business for years. It’s driven off a ‘we’ll run your mess for less’ value proposition for CIOs seeking to get out of the infrastructure management business. The truth is, there are big opportunities here to use automation and cloud migration to streamline the costs and capital requirements for infrastructure. So NewCo can also pursue an interesting growth path.”
According to Forrester principal analysts Bill Martorelli and Brian Hopkins, the GTS business has been underfunded for a long time. In a note responding to the IBM news, they wrote: “The hope is that GTS in its new life will see greater investment, and that as a pure-play infrastructure management service, it can be operated for growth (in the account) and profit (through automation) at a much lower cost of capital, using debt instead of equity to fund growth and acquisitions.”
In the presentation that accompanied its first-quarter 2020 earnings, posted on Seeking Alpha, the company highlighted the tight integration between the Global Business Systems (GBS) division, which is being retained by IBM, and GTS “to address the cloud opportunity”.
Now that GTS has become NewCo and IBM retains GBS, where does this leave this cloud opportunity? Forrester’s Martorelli and Hopkins point out that although NewCo is a $19bn business with thousands of customers, it lacks lucrative areas of IBM’s existing business, such as the high-growth cloud advisory services, its technology support services, and managed security services.
“Without the benefit of high-growth and high-profit segments, NewCo’s prospects may question long-term viability,” they wrote. The pair urged IBM’s existing customers to take stock over the coming months and devise sourcing strategies accordingly.