International Business Machines Corporation (IBM) Bank of America 2022 Global Technology Conference (Transcript)

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International Business Machines Corporation (NYSE:IBM) Bank of America 2022 Global Technology Conference June 7, 2022 12:30 PM ET

Company Participants

Jim Kavanaugh - Senior Vice President and CFO

Conference Call Participants

Wamsi Mohan - Bank of America

Wamsi Mohan

Hi. Good morning, everyone. Welcome to day 1 of our technology conference. I'm Wamsi Mohan. I cover IT hardware and technology supply chain. Pleasure to welcome you all here and especially delighted to welcome IBM EVP and CFO, Jim Kavanaugh, here today. Thank you, Jim, for being here. We really appreciate it.

Jim Kavanaugh

Thanks so much, Wamsi. I appreciate being here.

Question-and-Answer Session

Q - Wamsi Mohan

Jim's had a long career at IBM. He's been the CFO for four years. There's been tremendous amount of change over the years. He's had many, many, many roles of operation, finance treasuries covered the gamut. So Jim delighted that you could take some time and hope to learn something new, as I always do from you.

To kick it off, maybe it would be helpful to get your perspective on how the company has changed over the last four years since you've become CFO. There's been so much change that has happened both operationally, strategically. I would love to get your perspective to kick it off.

JimKavanaugh

Sure. Great place to start. Obviously, today, we firmly believe that the IBM company is a fundamentally different company than when I took over as CFO four years ago. We've been on an accelerated transformation over the last handful of years, really led by the strategic acquisition of Red Hat and the strong adoption and performance that we've been able to deliver. But it's all been centered around what we believe are the two most transformative technology shifts that are going to occur in the marketplace, one being hybrid cloud, and two being AI.

So if you think about IBM today, we've had a very distinctive point of view for quite period of time around where the market and what we call the ARC shift and technology was going. One, we believe the world was going to be multi-cloud; two, we believe that workloads are going to have to operate in multi-environments, from public to private to on-prem all the way to the edge; and three, we believe in the tighter integration of hybrid cloud and data and AI and security. That's what IBM is today, a very clear focus around hybrid cloud and AI.

But I think to your question, the core of your question really gets at the tough work that we've been doing for the last few years about transforming the operating model to execute on that strategy of hybrid cloud and AI. And just touching on a few things around the operating model shifts to give you an appreciation of what we've done here in IBM: one, tremendous amount of portfolio optimization. If you think about that portfolio optimization, it's about driving a hybrid cloud platform-centric company with an integrated value prop built on Red Hat, software, consulting, underpinned by IBM infrastructure.

But it's also many divestitures we've done over the years, and most recently, the separation of our Managed Infrastructure Services business to unlock value through focus. We've also been investing significantly to transform and drive a sustainable growth portfolio over time. What are those things? One, as of yesterday, 25 acquisitions in the last couple of years. We've been building out and enabling ecosystems and strategic partnerships. That's one thing I think very much underappreciated as to what Arvind has brought to the company overall as Chairman and CEO is opening up the IBM company. And we've also been investing significantly in skills, talent, capability.

And then the third is, I think, with the separation of Kyndryl is really about driving a much more focused, streamlined digital enterprise, redesigning our go-to-market model, aligning our incentive structures, really driving a growth mindset and a culture which is very much needed in IBM overall. So you bring all that together, the strategy alignment, clear focused hybrid cloud AI, the operating model changes, portfolio, go-to-market, investment, M&A ecosystem, it really lends itself to today's IBM's investment thesis, higher revenue growth profile, higher operating margin profile, strong free cash flow yield, lower capital intensity and higher return on invested capital. So we feel pretty good about where we're at.

Wamsi Mohan

I feel like you set the agenda for all the topics that we want to hit here.

JimKavanaugh

It's always good to get everything out of your first question, then you could pivot off there anywhere you want to go.

Wamsi Mohan

No, that's perfect. So maybe to start off on revenue growth, right? We've had sort of a decade where the portfolio has been different, priorities have been different, and now we're getting to a point where you're targeting mid-single-digit revenue growth. And it would be helpful, I think, for the investor community to understand what are the things that are going to build up to that mid-single-digit revenue growth?

JimKavanaugh

Yes. A great place to start there, too. Really, the operating model changes we just talked about, all the tough work that's been done in the last couple of years has all been centered around driving sustainable growth, both in revenue and in free cash flow, our two most important measures overall.

But if you look at it, you go back to our Investor Day in October, post the separation of Kyndryl, we laid out IBM's midterm financial model from 2022 to 2024. And what did that model articulate? That model articulated our guidance around how we're going to drive our portfolio. Top line growth, mid-single digit to your question. Underpinning that growth profile was a big mix shift to higher growth factors in our business, that being software and consulting now 70% of our overall portfolio and also a high-value recurring revenue base that greater than 50% of IBM's revenue is recurring revenue. Those 2 naturally lend itself to operating margin, and that operating margin and leverage translates into high single-digit free cash flow generation $750 million annually and about $35 billion cumulatively from 2022 to 2024.

But to your question about sustainability at top line, let me unpack it really from how we manage the company across our external segments because I think that's the most appropriate from your perspective of getting the sustainability point. If you think about that mid-single-digit growth, let me start with consulting. Consulting now 30% of our revenue overall. By the way, that 30% of that revenue now is targeted to grow high single digit. By the way, the market is mid to high single digit in consulting and revenue, so some share take overall. That high single-digit revenue growth in consulting will generate two points of IBM's mid-single-digit revenue growth.

How are we going to do that? One, we've transformed our consulting portfolio into business transformation services and hybrid cloud services. That is a $350 billion TAM that's growing 20-plus percent. Our composition of our consulting business now is over 45% in hybrid cloud, and it's grown on a trailing 12 months, 32% overall. You couple that with the investments in building out ecosystem partnerships, skills capability and also from a standstill over the last 18 months or two years, we've been aggressively investing in M&A. I think 18, 19 different consulting companies over time that have been driving nice velocity. So two points of IBM's revenue growth comes out of that high single-digit consulting.

The second is Red Hat, and we've been very pleased with our Red Hat performance, and we're three years into the acquisition now. Inception to date, we've been growing high teens overall, taking share. And I think it's a great instantiation of the value of IBM and Red Hat together, leveraging our large enterprise incumbency and also our global scale.

Red Hat, we've targeted to grow mid to high teens, pretty consistent with what we had been doing for three years. That generates another two points of revenue growth. So two from consulting, two from Red Hat, leaves one point left to go to get to mid-single-digit sustainability, and that's going to come out of our base IBM hybrid cloud and AI software that's automation, data AI, security.

And again, out of that, one, we've been investing in bringing out new innovation technology, our cloud packs containerized software with -- Wamsi, we're very early in those innings. We're about 20%, 25% penetrated, seeing nice acceleration over 100% NRR that we've been reporting on each time. We've also transformed our whole go-to-market model, which is going to drive productivity in more technical and experiential. And we've been building out those same ecosystem partnerships to drive our software attach, which is very sticky overall.

And M&A will also play in software. And we think it's going to generate probably about one point of growth in our software portfolio. So you bring two points of consulting, two points of Red Hat, get the point out of software. And by the way, you look at the last couple of quarters, we've been delivering on that mid-single-digit model ex Kyndryl which is on top of the model overall. And with that performance the last couple of quarters in April, we took our full year guidance up in 2022 overall to the high end of our mid-single-digit model. So we feel pretty good about it.

Wamsi Mohan

No, that's a great summary, and I do want to get into some of those pieces. But you just mentioned Kyndryl. There was some anxiety around how is this like spin-off going to impact the business overall at IBM, and you guys clearly are delivering very well. How should -- how important is Kyndryl to your contribution of sustained revenue growth?

JimKavanaugh

Well, Kyndryl, overall, first, we have a very strong strategic partnership with Kyndryl. Many of our large enterprise clients were both IBM and Kyndryl clients. This wasn't a separate independent business unit that we had to separate. I will tell you, my team, both from a CFO hat and from running the operations for the company, this was a very difficult separation. It was a very integrated model which, by the way, delivered tremendous value to IBM for decades as a platform to drive a channel for our hardware and software.

Now with the fundamental shifts in technology, the real bifurcation between applications and cloud world and infrastructure managed services, we lost the synergistic effects, and that led to the strategic narrative around spinning out Kyndryl.

But Kyndryl is a great strategic partner. We still have a tremendous amount of business with them both ways. We're their largest client and they're our largest client per se. But when you look at dependency of that, a lot of that -- most of that, I should say, of the revenue sold into Kyndryl is high-value, mission-critical sticky software that is recurring revenue under contract. So when you think about volatility, we don't expect a lot of volatility overall.

Wamsi Mohan

Maybe that's a good segue to talk about the resiliency of the business model. We ran -- we did some work looking at which stocks perform well when you run into a recessionary scenario and which are the most resilient from an earnings standpoint, and in coverage universe, Apple and IBM are the two companies that really came across as having business models that could survive.

JimKavanaugh

That's great company.

Wamsi Mohan

Yes. Yes, that can survive some of the macro shocks, which we've seen a bunch of already. And so I'm curious, Jim, maybe you could elaborate on sort of how you think about the resiliency of the business model, especially given some of the portfolio changes that have happened, including the separation of Kyndryl divestiture, some of the Watson Health assets. And so are you thinking that how much of this business model has got resiliency towards a slowdown versus a recession? How should investors think about that?

JimKavanaugh

Yes. Well, it's obviously very important in the very volatile, uncertain market we're operating in today. But Wamsi, as you know me quite well, I'm not trained to be an economist. So I'm not going to try to be one here today. But I'll give you a perspective as CFO.

Wamsi Mohan

Sure.

JimKavanaugh

We talked a little bit earlier before we get up on stage, spending a lot of time on making sure we drive scenario modeling around any macroeconomic exogenous impact. I think all CFOs are doing this today. And by the way, in recessionary situations, no company is immune. But to your point, we've done the same piece of work. We have fared relatively better than others during very difficult challenging macroeconomic times. Why is that the case? I think when you look at the portfolio, you look at the business model composition from a macroeconomic profile. We have built in diversification by design. What do I mean by that?

Number one, geographic diversification. We operate in 170 countries around the world. Not all markets go through the same diverse -- curves. So by design, we have natural hedges built into that by being in so many different markets. Second is we have very broad industry diversification. I think we participate in 17 different industries across the board. And very similar, they all don't go through the same curves of recessionary impacts over time. And we saw that through the pandemic. Some industries actually accelerated, others got hurt, and we were on the good end of that diversification curve.

Third, to your question, our client segmentation profile is very much enterprise focused, large enterprise focused. We serve, I think, over 95% of the Fortune 500 companies. 80% of our revenue is in the top 1,000 accounts. So many recessionary times hits consumer, small medium business early. We are a little bit immune to that.

And then fourth, all of the tough work on the portfolio, we've got a portfolio mix that has over 50% of our revenue recurring and that's high-value recurring revenue. Our software base of business, which is about 40% plus of IBM, 80% of that is high-value recurring revenue. So the diversification of geos, of industries, of client segmentation and our business mix provides some stability in revenue, profit and cash during these very challenging times.

Wamsi Mohan

Yes. No, thank you. I think that the portfolio has been very resilient to macro shocks. I mean, obviously, you have a transactional business that is subject to some of the same volatility, but your recurring base has been extremely resilient.

I was wondering, Jim, maybe we could pivot to software a little bit and talk about the growth elements that you referred to. If you go back historically in time, it's been lumpy. You've seen some quarters where there's been very good growth. Some other quarters, not. So when you think about unpacking that mid-single-digit growth in software, what are the building blocks to that?

JimKavanaugh

Yes. Well, software is a very integral part of our hybrid cloud platform-centric thesis. Why? 40-plus percent of IBM today, post the Kyndryl separation and margins approaching 30% over that midterm model, and it drives 75% of our EBITDA and our free cash flow. So very good place to start overall.

When you think about our software portfolio today, our software portfolio is really a growth vector and a value vector. And over time, to your point, we've had some volatility in this business. But if you think about what we've done about repositioning through organic and inorganic investment, our growth vector, which we call hybrid platform and solutions. That is our Red Hat business. That's our automation business. That's our data and AI, and that's our security portfolio. That's about 75% of IBM software composition overall. That business is targeted to grow high single digit. How do you get there?

First, that consistent performance of mid to high teens at Red Hat delivers 5-plus points of growth to that high single-digit number. We got to get a few more points now out of our automation software, which is doing extremely well. You just saw last quarter. growing right around 10% overall. The last couple of quarters actually have been doing extremely well. Our data and AI business, and we had a nice recovery in the first quarter on the security business at high single digit.

Underpinning that, what do we have? One, we've got a business composition that's 40-plus percent aligned to where markets and growth are at, that being hybrid cloud. We've got about a $9 billion business underneath hybrid cloud that's growing on a trailing 12 months, 25% over time.

Two, I talked a little bit about new innovation in cloud packs, very early, but seeing nice velocity and greater than 100% on NRR; three, building out and scaling these ecosystem partnerships. That's what Schlumberger most recently with McDonald's and what we've been able to do with them. But it's also Salesforce, SAP, many others that are building on that.

And then also, we're expecting to get productivity out of the whole redesign of our go-to-market. What do we do? We focus it on technology. We focus it on technical and experiential, and we're seeing some nice early returns out of that overall. And then we're going to deploy capital to go take care of opportunistic M&A opportunity, and we expect that to deliver a point to two points within that software portfolio.

So growth vectors, 75% of that business targeted to be high single digit. Last couple of quarters, we've been in that zone overall. The remaining 25% is our value vector. That's our transaction processing business. That's where we've had tremendous amount of volatility just based on client buying behaviors, entering the pandemic, during the pandemic and now coming out of the pandemic. The beauty about that, it's mission-critical. It's sticky. It has high renewal rates overall, and we expect that to be consistent with market down low mid-single digit overall. You put all that together, it gets you a sustainable mid-single-digit growth profile. And coming out of the last couple of quarters, we just guided here in April that we are confident in our mid-single-digit model for 2022 and well on our way to our midterm model overall.

Wamsi Mohan

Yes. That's great. So some of the underpinnings of this is really around the growth in Red Hat and Red Hat you've said mid-teens over the course of high teens, I guess, a little over the course of since the acquisition, but you guided to about mid-teens here for growth. What is driving that? Like how is this mid-teens growth of this asset sustainable? And what have you done differently with Red Hat relative to maybe prior acquisitions that maybe are not quite as large, maybe at the times that they were done, they were somewhat large. But we've seen that Red Hat has performed extremely well over these three years. So maybe you can share some color on what's really different there.

JimKavanaugh

Yes. Well, like I said earlier, very pleased with the performance, three years in inception to date. And really, when you go back to the strategic thesis around Red Hat, it was really predicated on where I started upfront, which was we had a point of view about the ARP shift that was going to happen in the technology industry. That being multi-cloud world. By the way, that's a reality today, 75% of enterprises have two or more clouds today. By the way, only 25% of the workloads are in public cloud. So where we might have thought three, four, five years ago, 100% of the workloads are moving to a public cloud, it has not happened for a variety of reasons.

Two, data and AI are exploding and they need AI at scale. In the synergistic effect of IBM's software around our automation, data and AI and security, coupled with our horizontal hybrid cloud platform of Red Hat, which is built on Enterprise Linux, containers and Kubernetes, we've seen significant synergistic value between the two.

And then third is we've seen a tremendous amount of client demand as every company is shifting to capitalize on digital transformation for sustainable competitive advantage. We've built up a $4.5 billion book of business around our consulting business that is driving the tip of the spear pulling our Red Hat capabilities overall in scaling and adopting that platform while also pulling IBM core blue software technology.

So when you look at, I'm very pleased overall growing high teens inception to date for three years. We're leveraging part of that strategic thesis was bring Red Hat in, leverage our large enterprise incumbency position and also leverage our global breadth, which we know how to do. We know how to do software acquisitions, and we've proven that for decades on decades.

But when you look at it right now, just some of the stats around Red Hat, One, we've got over 4,000 clients now running our hybrid cloud platform. That's up from nearly 800 pre-acquisition. We've been taking share in Red Hat Enterprise Linux, Red Hat OpenShift. Our Red Hat OpenShift, our hybrid cloud platform is up 4x in revenue since the time of acquisition. We got about a $6 billion book of business in backlog, strong renewal rates, NRR over 100%. We feel pretty good. So I think the synergistic effect of IBM and what we bring from a consulting tip of the spear and our automation, data and AI software and the embedded on top of that platform is driving the scale overall.

Wamsi Mohan

That might be a good segue, Jim, to go into consulting. You guys have really turned the business around. I know there's a lot of hard work underneath in terms of reskilling go-to-market. There's a whole bunch of changes that have happened at the organization. So you're targeting double-digit growth in 2022. What are some of the key drivers here that get you there? And how do you think about that, the progression of that?

JimKavanaugh

Yes. Well, we're seeing very strong demand in the marketplace. We've been talking about them. By the way, Arvind and I saw this inflection shift coming out of the pandemic in the second half of last year. We invested significantly to go capture that. You saw first quarter, our consulting business was up 17% at constant currency overall. Consulting plays a very integral role in that hybrid cloud platform thesis as I talked about the synergistic effect because it capitalizes on the multiplier effect. What we talk about our platform, when we land a hybrid cloud platform, there's an economic multiplier on top of that, $3 to $5 a software for every dollar of platform we land, $6 to $8 of services for every dollar of platform we land. And we're seeing that play out in our consulting business today.

If you look at some of the stats coming out of the first quarter, one, we got about an $8.3 billion book of business in hybrid cloud and consulting today. That's what some would call digital, digital transformation services. and hybrid cloud services. That's growing 32% on a trailing 12 months in a market that's a $350 billion TAM market.

We're also seeing our Red Hat engagements $4.5 billion book of business. We have over 1,000 clients with Red Hat engagement and consulting since inception of the acquisition. And to my earlier point, opening IBM up now, the strategic partnership leverage and velocity we're getting around ISVs with SAP, Salesforce, Adobe and with hyperscalers around AWS and Azure. I think we doubled our signings in the first quarter with hyperscalers and more than 50% growth in our signings book of business across all ecosystem partners.

And then we've been investing in acquisitions. We got about three points of tailwind of growth that's built in on an inorganic side, and the acquisitions are ramping nicely. So I think you put all those pieces together, coupled with the tough work that was done over the last few years to redesign the operating and business model of consulting, we feel pretty good. And to your point, coming out of first quarter, we actually took our guidance up for the year on consulting above our midterm model. So we said we're going to grow low double digit overall, and we feel pretty good about it.

Wamsi Mohan

So you guys delivered very strongly on revenue across the board. I think margins were a little bit softer in consulting in the quarter. As you think about the levers that you have, I think the math from the management commentary feels like you really have a lot of confidence around your ability to improve that profitability along with the revenue growth over time. And so what are some of the levers there, both at gross and PTI level that get you to margin improvement as you go through the course of the year? And is there a scenario where you can see consulting margins up on a year-on-year basis as you exit the year?

JimKavanaugh

Yes. So when you think about our midterm model, let me start there and then I'll get to 2022, okay? The midterm model, we said top line revenue growth mid-single digit, with an improving business mix composition of growth vectors, software and consulting 70% and a high-value recurring revenue. Those two naturally lend itself the operating margin leverage overall. And then that operating margin leverage delivers high single-digit free cash flow, $35 billion about cumulatively over the years.

So we see over the midterm horizon, not only improving revenue growth profile, we see an improving operating profit margin profile based on the leverage. So what are some of the underpinnings behind that? Number one, now post Kyndryl separation, 70% of our business being in high-value, high-growth vectors, software being 40-plus percent, software driving 75% of our EBITDA and cash, we get a natural mix benefit each year as we grow mid-single digit of our software portfolio overall.

Two, when we look at the investment capability of what we've been putting in place over the last few years, we made a conscious effort to reposition our disclosures and guidance away from EPS, and we went to revenue growth to transform the cultural mindset of this company to get back to revenue growth. And we also shifted it to free cash flow generation. When you think about that, the second part was taking those investments and starting getting return on investment of transforming our go-to-market model, expanding an ecosystem capability over time.

And the accretive value of acquisitions as you move over time. So I think all three of those pieces will start playing some tailwinds as we move forward. And in particular, around consulting because that's where at a gross margin level, we've seen gross profit dollars flat in the first quarter, but our gross margins were down 350 basis points. What we're seeing there is, one, the investment that we put in place, that we still have tailwinds going forward on getting accretive value. We've seen the dilution impact us, coupled with the highly inflationary market because it's a reality in today's world.

So the margin benefit is going to get better in consulting as we start scaling those acquisitions to accretive value, all of the tens of thousands of consultants we brought in over the last 9 months. Now we're starting to see the utilization ramp of productivity. And that will play out as we go out throughout the year.

And then in pricing optimization, 60% of your business is under contract. We're still rolling out business from what we signed middle of last year. Now we're going to be starting to see some tailwind as we move forward. So we feel pretty confident about operating margin leverage through the rest of this year. We guided this year on about, what, four to five points of operating profit margin, and we guided about three to four points over our midterm horizon, both in software and consulting overall. So we feel pretty good.

Wamsi Mohan

When you think about maybe pivoting to infrastructure, I want to come back to your cumulative free cash flow comment. But on infrastructure, just to round out sort of the business segments. Infrastructure has -- you guys have had a recent announcement of the new z16. I think infrastructure for you is not really so much of a growth vector. It's sort of plus/minus around depending on the cycle that you're in. So maybe can you help us think through the strategic value of infrastructure? And secondarily, how should we be thinking about this mainframe cycle given the timing of the launch of the mainframe?

JimKavanaugh

Yes. So infrastructure, to your point, growth always follows innovation cycles, right? And we just announced actually last week, we GA-ed our new -- our next innovation technology around z16, which we're very excited about. Embedded AI at scale. We have an on-chip AI accelerator that's embedded in the new mainframe, cyber resilient security and also a whole new set of cloud-native development capabilities that excited about building up our order book as we speak, big month of June expected here.

But that cycle, as you know, let me talk mainframe, then I'll get to infrastructure. Mainframe, we operate as a platform in the company. We've built the new innovation technology of z16. I just talked about with that distinct value proposition. That's coming off of our most successful mainframe product cycle, the prior generation z15. We shipped the most MIPS ever in any history of any program. during a pandemic/recession, 30 million MIP ships over the last 12 quarters.

Our installed MIPS capacity is up 45%. Why is that important? Because running mainframe as a platform, it has an economic multiplier effect of capitalizing on software and services around all that installed MIPS capacity. So that profit comes over time. You get the profit from the hardware in the system box upfront. You then build on attach rate of software of maintenance, infrastructure support of financing profitability and of our consulting services business over time. So we feel pretty good and excited overall. And by the way, that's why we took the guidance up in April above that model because we're into a cycle year overall.

But infrastructure overall is important to our hybrid cloud platform thesis because, one, it is our value vector. It generates a significant amount of profitability and cash that we utilize for financial flexibility back into our growth vectors. That's our capital allocation strategy, investing organically, inorganically. That's our secure and modestly growing dividend as we move forward. And you look at 2022, we have a whole new product lineup in Power10. We just announced z16, and we'll continue to come out with new innovations in our storage portfolio throughout the year. So should be a pretty good year for infrastructure in 2022.

Wamsi Mohan

How do you think about -- I mean, there are concerns about comping that in '23 in some ways. So when you think about the plus/minus and sustainability going into '23, how should investors think about that?

JimKavanaugh

Yes. If you think about it, you go back to my point about how do we manage the mainframe. The mainframe is managed based on a platform. So while, yes, in some years, we were on a down product cycle, the volatility of that IBM Infrastructure segment will get offset based on the capacity and multiplier effect of our software and our services later in that product cycle. So early part usually ends up in infrastructure systems. Latter part ends up in software and hardware. But we manage it across the board from a cash and an overall profitability level overall.

So I feel pretty good. But when you think about mainframe, we're announcing it here late March -- or excuse me, May 31. So we'll get some volume in the second quarter. We'll get a half a year in '22. We'll get another at least half a year, probably more, if it's like a z15 cycle that will mitigate the volatility over time. But to your point, we expect in our business model plus or minus a couple of points in the overall IBM infrastructure depending on cycle. But again, having that breadth and synergistic value that multiplier of software services with the systems, we should be able to balance that out across the board.

Wamsi Mohan

I got a lot of questions around the free cash flow, and you alluded to the $35 billion target or cumulatively over three years. How do you get there? How do you bridge from '22 to 23 to '24 to get to your $35 billion in free cash flow, especially when you think through a lens of some of the charges that you might be absorbing here in the near term that maybe don't recur?

JimKavanaugh

Yes. Well, I think you just answered the question right there when I get asked this all the time. So we talked about in that midterm model that we would generate high single-digit free cash flow annually. That's about $750 million, off of growing revenue at mid-single digit with some operating leverage underneath it, right? That translates into about $35 billion over the cumulative period.

When you take a look at that $35 billion, we entered 2022, we guided $10 billion to $10.5 billion as the first instantiation of that three-year model overall. That $10 billion to $10.5 billion, by the way, which we reiterated in our April earnings takes into account the decision to exit our Russia business, which was highly profitable over time. But that is up over $2-plus billion year-over-year.

Also included in that 2022 guidance of $10 billion to $10.5 billion to your point, we still have cash charges from our structural actions of 4Q '20. Those cash charges, by definition, make the three year time period nonlinear. So you take the business profile on a sustainable basis, you get about 750 per year, the structural actions, which this year is still going to be $500 million, $600-plus million, that turns into a tailwind in '23 and '24.

So you finish 2022 in that range of $10 billion to $10.5 billion. The business profile will generate that high single-digit cash flow. We'll get the tailwind from those structural charges that will play out in '23 and '24, and we still have some balance sheet optimization over time that gets you in that ballpark of about $35 billion, which gives us tremendous financial flexibility to execute on our capital allocation strategy overall, both organic and organic investment.

Wamsi Mohan

Which I know we're almost running out of time here, but I did want to dedicate a little more time to this, but I'll try to make it quick, which is when we hosted a call with Arvind earlier, he did mention that IBM had the flexibility to do significantly larger acquisitions. You guys have the your free cash flow generation plus taking on a little bit more maybe debt and doing something larger. How should investors think about how you're thinking about that same framework of -- potentially, I mean you already said you -- acquisitions are part of the business model. But the rate and scale or the pace is there valuations that have come in now that make it more attractive to do something faster? Is it -- can the size be larger? How should investors just think about that?

JimKavanaugh

Yes. It's a good place to kind of wrap up here today. I mean we're obviously operating in a very different market environment and valuations are becoming very attractive versus where they were 18 months ago. When you talk about our free cash flow generation or additional debt capacity, we're very comfortable operating where we're at. We got about $40 billion of firepower.

Our capital allocation strategy hasn't changed, always invest in the business organically, inorganically; two, secure a modestly growing dividend, which is very important to our investors overall; and three, we feel pretty comfortable with the investment-grade profile of our targeted leverage ratios and where we're at today. So we've got the firepower.

And by the way, we have also alternative funding sources, whether that's cash, that debt or some forms of equity. But our criteria around acquisitions have never changed. Size has never been the point. Everyone always wants to ask about a size. You're going to do a large transact. Our criteria is always centered around strategic fit, synergistic value to our hybrid cloud platform, definitely financial return profile and quick free cash flow accretion. So are we busy looking at acquisitions daily? Yes. We'll leave it at that.

Wamsi Mohan

Okay. Well, thank you, Jim. We're just about out of time. We really appreciate you being here. Thank you for taking the time, and there's always so much to talk about the company. So thank you again.

Jim Kavanaugh

Appreciate it so much. Thanks, Wamsi.

Wamsi Mohan

Thank you very much. Thank you.

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