IBM has announced that it is spinning out the Managed Infrastructure Services unit of its Global Technology Services division as a separate company. CEO Arvind Krishna said that the move was designed to enable IBM to focus on its open hybrid cloud platform (built around the Red Hat acquisition) and AI capabilities, while the yet-to-be-named NewCo will have greater agility to design, run and modernize its clients’ infrastructure.
The separation is expected to be wrapped up in 2021, and the new arm will have an annual revenue of approximately $19bn (based on its run-rate in the 12 months to June this year) and pool together 90,000 employees supplying hosting and network services, services management, infrastructure modernization and hybrid multi-cloud management.
Digging a little deeper into how the split will work, New IBM will strongly focus on products (open source; and including “as a service”), modernization projects and technology. It will also strongly extend vertical platforms, covering deeply and broadly the specific processes, exploiting data and using AI, but also including specific vertical certifications for their public cloud. The NewCo takes on Technology Services (GTS) Managed Infrastructure Services (including Managed Hybrid Cloud), infrastructure consulting and system integration, strategic outsourcing, and hyperscaler services (managed & C&SI). Where the application management business will be located is not yet known.
There will be two separate companies, that will cooperate closely. There will also be separate partnerships with companies like ServiceNow (NewCo for Infra operations, New IBM for “intelligent DevOps/AI”). From an internal IBM perspective, the changes are relatively limited. For the software folks, GTS often felt like a different company, with separate sales, projects, etc.
From PAC’s perspective, we see this as a fascinating move, and one which carries potential benefits as well as risks.
In many ways, the announcement is not a major surprise. It follows IBM’s long-standing strategy of spinning out or selling those parts of the group that no longer deliver the margin or top-line growth to keep investors happy. The company has shrunk by more than a quarter during the last decade, following the sales of operations including its x86 and PC hardware activities, software assets in-cluding Notes and Domino, and most recently its marketing and e-commerce assets to a private equity group.
The initial investor response to the announcement has been positive and it is easy to see why based on a look at the recent Q2 numbers. Total revenue decreased by 4% (constant currency), yet while both Software (+4.6%) and Systems (+6.3%) grew, all the services businesses contracted: Infrastructure & Cloud Services by 5.1%, Technology Support Services by 6.4% and Global Business Services by 6% (with BPO decreasing by 12%, while Consulting only decreased by 3%). Moreover, Global Technology Services (Infrastructure & Cloud Services and Technology Support Services) reported the lowest pre-tax margin of the group, at below 4%. By comparison, GBS posted over 9% margin, Systems (hardware) 12% and Software 21%.
From a market perspective, the move highlights that we have reached a tipping point between the on-premise legacy world and the cloud-centric digital era. IBM remains the undisputed heavy-weight in the infrastructure outsourcing world at a global level. Based on our most recent rankings, we put it as much as 40% ahead of nearest challenger DXC (itself going through a programme of spin-outs and restructuring), with whom it is also neck-and-neck for the top spot in Europe. The NewCo will face a small and familiar group of competitors, with only DXC, Atos, T-Systems and Fujitsu operating on an international level, above regional players such as OBS, Swisscom, Proximus, TietoEvry, Indra and NEC.
By breaking the link between the infrastructure services business and IBM’s own cloud proposition, the former can position itself as an independent player to support clients in their multi-hybrid cloud journeys. IBM is the only game in town that combines significant proprietary cloud proposition and a large third party services operation, although we have not seen too many occasions when this has been a major blocking point with customers.
The services business has got much better at recommending a horses-for-courses, best-of-breed approach to platform selection. But from a customer’s perspective, the separation would also draw a clear line between IBM’s public cloud proposition and its private cloud offerings. One long-term challenge for IBM customers has been to navigate the different moving parts of the organization, and having different IBM teams pushing conflicting offerings is not unheard of.
One question that can be raised is about the timing of the deal, coming as it does as we are seeing a new wave of major end-to-end outsourcing deals – running from infrastructure through to applications with a strong transformational focus – as businesses look to adapt at speed to the post-Covid environment. The annuity managed services business also offers a stable base of revenue at what is likely to be a time of continued volatility.
We don’t believe that the spin-out will significantly impact IBM’s ability to pursue these opportunities in partnership with the NewCo. The truth is that the outsourcing market has changed, and new deals are not won or lost by central bid teams buried within the outsourcing unit – they are nurtured by the industry-focused consultants that have built relationships with the boardroom stakeholders that are driving the digital transformation strategy forwards. There is a good case to make for the acquisition of PwC Consulting being IBM’s most important acquisition of the last 20 years.
The move will put a lot of pressure on IBM to succeed in the public cloud arena, which is by no means a foregone conclusion. The development of industry-specific propositions for key markets such as financial services have a lot of potential as organizations look to migrate more sensitive and critical workloads.
The separation will represent IBM’s largest spin-out to date, and it begs the question, what does the company stand for today? The old saying goes that “no-one gets fired for buying IBM,” and a big part of that was due to the power of the brand. But it was also due to the soup-to-nuts proposition that the group could provide its large enterprise customers, and some customers may perceive that IBM will lose a little bit of its differentiation from its peer group.
One of the accusations that has often been levelled at IBM over the last couple of decades, is that it has focused more on financial engineering rather than investing for growth. However, the purchase of Red Hat was a big, bold move that judging from the customer stories we heard about at this week’s Think Digital event, is now the source of a lot of goodness across the organization. The company’s R&D engine remains at the forefront of developments in areas such as AI and Quantum computing.
A final takeaway is that the plan for the spin-out provides further evidence of how difficult it is to balance legacy and growth businesses. Attracting and retaining the talent to support topics as diverse as AI algorithm development and mainframe maintenance requires different cultures and approaches, and IBM’s move suggests that it is hard to do this under the same roof.