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IBM Delivers High-Margin Through Cloud

NEW YORK (TheStreet) -- IBM (IBM - Get Report) has been cutting a clear path toward a higher-margin business through its willingness to walk away from its lower-margin hardware businesses, and further its aggressive entry into the cloud.

"They're making a pretty big bet on the cloud and over time that should offset some of the headwinds, certainly the structural headwinds on the hardware side," says Peter Wahlstrom, an equity analyst for Morningstar Investment Services. "They know that ... 'we might be a little bit smaller, but we should be more profitable.'"

The company on Wednesday reported its cloud revenue was up more than 50% in the first quarter, booking its third straight quarter of cloud revenue of more than $1 billion. For cloud delivered as a service, the first-quarter annual run rate was $2.3 billion, doubling year to year.

IBM is now well on target to meet or exceed its objective of $7 billion in cloud revenue by the end of 2015. With its cloud business ending 2013 at $4.4 billion in sales, IBM will now only need to grow at a compound annual growth rate of 26% over the next two years to reach that $7 billion goal. In first quarter, its growth rate was twice that rate.

While the company's cloud business has had an impact on IBM's x86 and Power hardware business, as cloud pursuits would do to every hardware provider, IBM's large software and services offerings in the cloud is enabling it to expand in areas where there is incremental, high-margin growth. Such areas include Software as a Service (SaaS), commerce, and workforce solutions.

Noteworthy is that a number of IBM's SaaS offerings, especially those added through acquisitions, are only sold as SaaS offerings, thus representing pure growth and not impacting existing, on-premise revenue streams. There are also offerings sold as both SaaS and on-premise solutions, such as Websphere, where the two delivery methods complement each other. Websphere grew 12% in the first quarter.

During the quarter, IBM announced investments of $1.2 billion to globally expand SofLayer cloud hubs, $1 billion to create cloud Platform for developers, and $1 billion to create the Watson business unit.

Holger Mueller, principal analyst and vice president at Constellation Research, said IBM's been coming out ahead of large public cloud competitors in the enterprise space following its acquisition of SoftLayer last summer. Since then, IBM has announced plans to double its software centers to 40 cloud datacenters in 13 countries. "Nobody has responded to that," Mueller underscores. Competitors including Amazon (AMZN) and Google (GOOG) each have about 20 datacenter locations to date.

A key attribute of IBM's SoftLayer is its bare metal server specialization; this is not found at Amazon, Google, or Microsoft (MSFT), which gives IBM an added advantage in the cloud for enterprise customers. "The bare metal capability of SoftLayer is more palatable to CIOs," Mueller explains. "A bare metal instance from IBM gives more visibility into its working than the virtualized competitors. Amazon and Google are very good at public cloud, but they are not as established like IBM in the enterprise, not a known entity in the enterprise, not who CIOs usually do business with."


-- Written by Andrea Tse in New York

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