Why Merrill Lynch Is Growing Incredibly Bullish on IBM

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International Business Machines Corp. (NYSE: IBM) is pushing the envelope in cloud services as well as artificial intelligence with its Watson program. However, the stock is actually down from its highs back in 2013. Things could be changing at IBM, as one analyst is calling for Big Blue to reach back to these highs again as the company has been gaining momentum over the past year.

Merrill Lynch reiterated a Buy rating and raised its price objective to a street-high $200 from $185. One thing this brokerage firm did note is that although Big Blue is not Amazon Web Services, its public cloud remains an incremental opportunity.

The firm believes that IBM is well-positioned to take advantage of its unique offerings of Watson Artificial Intelligence (AI; offered only on IBM Cloud), bare-metal server capabilities and IT services expertise, which it can leverage to gain share in heavy workload and hybrid environments.

Furthermore, Merrill Lynch thinks IBM should be able to secure a solid number four spot, behind Amazon’s AWS, Microsoft Azure and Google. Investors seem to neglect IBM’s Public Cloud penetration capabilities, which the firm believes could add $7 to $15 in value per share.

Merrill Lynch detailed in its report:

We look at Public cloud Infrastructure-as-a-Service (IaaS) and Platform-as-a-Service (PaaS) as the two segments where IBM, AWS and Azure compete. IDC estimates both of these markets are growing at a 30%+ compound average growth rate (CAGR) and will reach $46.3 billion and $35.6 billion for IaaS and PaaS, respectively, in 2020. We believe IBM could secure a solid #4 position in the Public Cloud (IaaS+PaaS) with 5% market share, behind AWS at 42%, Microsoft Azure at 23% and Google at 9% share.

IBM has 30 data centers located in 22 cities, across 16 countries, which compares to 42 for AWS and 32 for Microsoft Azure. The total server capacity at Big Blue is currently over 220K and compares to IDC’s estimate of total public cloud server capacity at 3.5 million for 2016. Multi-country and regional presence is important to keep data compliance and laws of local jurisdictions. The company also has a large breadth of offerings that are not too far behind in volume from the leaders AWS and Azure.

The firm gave this as its investment rationale:

We view IBM as a defensive investment given its high exposure to recurring sales, cost cutting levers, solid balance sheet, potential share gains, and relatively stable margins. We believe IBM will embark on further cost cutting, and enhance its services and software offerings through acquisitions. Longer term, we expect IBM to take share in IT spending with its Cloud and AI initiatives. We believe 2017 will be the start of a turnaround in fundamentals.

Shares of IBM were trading at $181.20 on Thursday, with a consensus analyst price target of $165.55 and a 52-week trading range of $130.88 to $182.79.