IBM: Big Blue Takes Cloud Seriously As It Acquires SoftLayer

| About: International Business (IBM)

Shares of International Business Machines (NYSE:IBM) hardly moved after "Big Blue" once again demonstrated its commitment to growing its cloud-offerings by acquiring SoftLayer Technologies. The company continues to demonstrate that it has the ability to adapt to changing external circumstances. IBM is taking advantage of both the opportunity as well as the threat which cloud-based solutions pose to its current business model.

The Deal

IBM announced that it has reached a definitive agreement to acquire SoftLayer Technologies, the world's largest privately held cloud computing infrastructure provider. According to people close to the deal, IBM has paid some $2 billion for the privately held company, which is currently owned by GI Partners, in an attempt to further strengthen IBM's position in cloud computing. IBM did not release any financial details regarding the deal, which is aimed to speed up the pace at which IBM's clients will adopt cloud-based solutions.

SoftLayer is headquartered in Dallas and serves 21,000 customers across the world from its 13 data centers located across the globe, with over 100,000 devices under management. Its servers allow clients to buy cloud services on either shared or dedicated servers, offering clients much needed flexibility. The combination of IBM and SoftLayer allows customers to use IBM's SmartCloud portfolio of solutions with great reliability, simplicity and security on the servers of SoftLayer.

SoftLayer's CEO Lance Crosby said in an interview that the company reported annual revenues of $335 million for 2012. The deal is expected to close in the third quarter of this year following regulatory approval.

Cloud Continues To Gain Importance

IBM is already one of the largest cloud providers and it plans to change its organizational structure to reflect this. It therefore forms its new Cloud Services divisions in which it will combine SoftLayer with IBM SmartCloud. The company already expects to generate $7 billion in cloud revenues by 2015, offering more than 100 SaaS solutions.

IBM's clients want to use the benefits of cloud, not just for individual applications, but for their entire company. The set up of the new Cloud Service division will help IBM in providing its services more efficiently and quickly.


IBM ended its first quarter with $12.0 billion in cash, equivalents and short-term investments. The company operates with $33.4 billion in short and long-term debt, for a net debt position of $21.4 billion. Given its access to financing and the large cash balances, a reported $2 billion deal can easily be financed.

IBM generated full year revenues of $104.5 billion for 2012, down 2.2% on the year before. Net earnings rose by 4.7% to $16.6 billion, while earnings per share grew much faster on the back of sizable share repurchases. Trading around $205 per share, the market values IBM at $229 billion. This values the firm's operating assets at around 2.2 times annual revenues and almost 14 times last year's earnings. IBM currently pays a quarterly dividend of $0.95 per share, for an annual dividend yield of 1.8%.

Some Historical Perspective

Long-term holders of IBM have seen decent returns as the company has always managed to change if technological innovation threatened its core business throughout its corporate history. Following the burst of the internet bubble, shares have traded in a $60-$120 trading range for most of the period leading up to 2010.

A recovery of the economy and increased payouts to shareholders propelled shares higher from that point in time. Shares steadily rose to the $200 mark at the start of 2012, and the company has traded in a narrow $190-$210 trading range ever since.

Between 2009 and 2012, IBM has managed to grow its revenues by a cumulative 9% to $104.5 billion. Earnings rose by almost a quarter to $16.6 billion in the meantime. Earnings per share growth was even more impressive as IBM retired roughly 15% of its share base in the meantime.

Investment Thesis

The acquisition of SoftLayer is just a drop in the bucket for a firm the size of IBM. The rumored price tag of $2 billion represents just 1% of IBM's own market capitalization. The rumored price tag values SoftLayer at roughly 6 times last year's annual revenues, a premium to IBM's own valuation, but not too excessive compared to other cloud names. The addition itself would boost IBM's cloud revenues by roughly 5% based on the company's target for $7 billion in revenues by 2015.

More importantly, it gives IBM a chance to compete with (NASDAQ:AMZN) in the market for public cloud server based solutions on top of its private cloud solutions it already offers. The cloud and big-data theme remain red hot. Earlier yesterday (NYSE:CRM) announced the acquisition of ExactTarget (NYSE:ET) in another $2.5 billion deal. Recent public offerings of Marketo (NASDAQ:MKTO), which provides a cloud based software platform, have been a huge success as well.

Still the overall deal is just a drop in the bucket for IBM but it highlights how important the firm thinks cloud will become in the future. Its $7 billion revenue target only makes up 6-7% of annual revenues and it is IBM's bet on future revenue growth and margin expansion. The company already spent billions on acquisitions in recent years in the field, including Cast Iron, Unica, Varicent and DemandTec, among others.

IBM's valuation remains fair as the massive buyback programs in recent years have boosted earnings per share. After a relative strong share price performance in recent years, don't expect spectacular returns in the short to medium term. Instead, bet on long-term returns as IBM continues to evolve in a rapid changing environment in order to stay relevant for many years to come as it takes the cloud seriously.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.