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This IT ‘dinosaur’ is roaring back to life – investors must buy now before everyone else realises

·4-min read
IBM
IBM

Quantum computing – the idea that the weird world of quantum mechanics can be harnessed to make faster computers able to solve problems that traditional ones cannot – has always sounded impossibly futuristic. So you may be surprised to hear that you can go on to one computer company’s website and start to use its quantum computers, via the “cloud”, right now.

You may be even more surprised by the name of that computer company: IBM.

That company, famous for its “mainframe” computers the size of a room, has for years been dismissed by IT professionals and investors alike as a dinosaur. But this is a dinosaur that’s starting to roar back to life. And the market has not yet realised the fact.

“It’s true that IBM was slow to react to changes in the industry, such as the move to cloud computing,” says Tom Morris, who holds the stock in his Liontrust Tortoise fund. “This was reflected in lacklustre financial performance over the past decade.

“But in 2019 IBM made a really clever acquisition: it bought Red Hat, which makes software that allows companies to manage their various different IT systems with a single control panel. Red Hat’s software is used by 94pc of the companies in the Fortune 500 [an annual ranking of America’s largest businesses].”

He said IBM had then set about rebuilding its entire business to make the most of the capabilities it had gained as a result of the acquisition.

“It started to rebuild IBM around Red Hat,” Morris says. “Red Hat’s software can connect companies to whatever data centres or cloud services they have. IBM’s infrastructure arm can provide data centres, storage or its own cloud service. Meanwhile its original software arm, the part not acquired from Red Hat, and its consulting business help its customers to use that infrastructure to best effect.”

In a symbol of the change represented by the Red Hat purchase and its subsequent reorganisation, IBM promoted the head of its cloud business to chief executive. “It was a totemic change that told staff and customers alike that IBM’s future was the cloud,” says Morris.

As part of its restructuring, the company span off one of its consulting arms, Kyndryl. This was, Morris says, a low-margin business involved in day-to-day management of customers’ systems, by contrast with the more strategic, high-margin consultancy business it has retained. “The new IBM is a cleaner play on software and cloud computing,” he adds.

About 40pc of sales now come from software, about a third from consulting and 25pc from its infrastructure arm. This is a very far cry from the business that sold those old mainframes to banks, airlines and other large companies that crunched a lot of numbers (it does however still sell mainframes to customers that need them). And, as we mentioned, it sells the opportunity to use its quantum computers.

“IBM’s hidden gem is its work on quantum computers, which are a product of its really impressive research department – IBM has filed more patents than any other American company for 29 years in a row, another indication that the ‘dinosaur’ label is misplaced,” Morris says.

“People in the industry say IBM’s quantum computers are very advanced. One of the concerns about this new kind of computing is that it will be able to decrypt currently unhackable security systems but IBM is doing a lot of work to develop safe security protocols for quantum computing and the American standards body has given its system its seal of approval.”

But you wouldn’t guess any of this from the share price: IBM trades at about 14 times forecast earnings and yields 5pc, or 8pc on a cash flow basis.

“We think it’s priced as a business that doesn’t grow but in fact it has forecast revenue growth in the mid-single digits and cash flow growth in the high single digits,” Morris says.

“The shares have been flat for so long that investors just don’t want to know, they have given up.

“Expectations are really low but if it can deliver sustainable growth you would expect it to be on more than 14 times earnings – maybe a figure in the high teens. IBM looks pretty cheap.”

Questor says: buy

Ticker: NYSE: IBM

Share price at 5.45pm: $129.32 (£107)

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