Better late than never. That’s probably what investors in International Business Machines Corp. (NYSE: IBM) are thinking now about the company’s decision to break its businesses apart. IBM has seen its share of change over time. Many people remember that IBM used to be in the personal computer and workstation business, and IBM also used to make typewriters and even electric motors before that. Now IBM will soon be able to say it used to be in the IT services businesses.

When IBM announced that it had plans to spin off its managed infrastructure services unit, the stock initially traded up 9.2% to as high as $135.50, but shares were up a more tempered 5% at $130.50 late on Monday. At issue here is whether this really was a “better late than never” story.

24/7 Wall St. has been critical of IBM for years. The story always has been a hard sell to investors, and the Dow Jones industrial average component migrated from one of the world’s top technology companies a decade ago into what some investors might call a “nothing burger.” Perhaps Ginni Rometty would prefer a different characterization, but IBM was a $200 stock during part of 2012 and the start of 2013, and it was $124.07 prior to announcing its split-up.

It probably sounds commendable that IBM now finally is able to break up of its key businesses. There are more than a few questions here that may still make this difficult for the investing community to handle. In fact, there may be more questions than there are answers as we look out into 2021.

24/7 Wall St. has broken out several areas that are likely to bring the biggest concerns in the coming quarters. There are likely many more areas of concern, one of which was that IBM already was poised to have one of the greatest explosive moves on earnings. One area that needs to addressed without comment is that IBM’s cloud and strategic imperatives simply were not large enough to make for two great companies until it acquired Red Hat.

These concerns have not been ranked, and there are obviously many issues that also need to be given consideration.

Backlog Shows Continual Shrinkage

IBM used to report its services backlog with every earnings report. Without getting into when that all stopped, the reason IBM stopped announcing it so prominently was because that backlog had been in decline for years. Fewer companies were in need of expensive outsourced IT professionals to show up in navy blue suits. IBM’s official press release covering the year-end 2015 showed a services backlog of $121 billion. Wedbush Securities had a note in early 2017 showing that backlog was $116 billion.

While IBM’s announcement indicated that the NewCo has relationships with over 4,600 clients in 115 countries, its backlog was shown to be $60 billion. IBM pointed out that the backlog is more than twice the scale of its nearest competitor, but the scope is about half of what it was at the end of 2015, before thinking about what may have been divested, closed or moved around in prior efforts. NewCo is expected to be focused solely on managing and modernizing client-owned infrastructures.

IBM’s Focus in the Cloud

As IBM has refocused strategic imperatives around the hybrid cloud, security, quantum computing, data and intelligence, and artificial intelligence, it did a lot more than just acquire Red Hat for $34 billion in 2019. IBM’s landing page for Ginni Rometty specified that IBM acquired 64 companies during her tenure as CEO and that over 50% of IBM’s portfolio was changed under her tenure. It also noted that IBM divested nearly $10 billion in annual revenue over that time.

Some investors wanted IBM to make this move to split long ago, but one sad reality was that the imperatives might not have been strong enough all on their own without the steady IT-services money supporting their growth. Looking forward, the higher growth IBM is expected to have over 50% of its portfolio in recurring revenues.

It is too soon to know what actions IBM will formally endure during this process. The press release noted that IBM will take action to simplify and optimize its operating model for speed and growth. Specifically, streamlining its geographic model, transforming its go-to-market structure and continuing to consolidate its shared services. The goal is to have “an enhanced financial profile with a clear trajectory for improved revenue and profit growth.”

These are buzzwords for layoffs (see below), office closures, eliminating or reducing lower margin projects and so on. All this comes with charges and disruption, even if it is a move to get ahead down the road. Those charges have been estimated further in this article.

A Long Separation Timeline and Lessons of HP

Holders of the existing IBM are going to own two companies as the deal stands today. It is always possible a buyer might come into play, but it is no secret the services has been in contraction for some time. IBM’s release indicated that the separation would end up as a tax-free spin-off to its shareholders, but it also gave the forecast that the deal would be completed by the end of 2021.

Hewlett-Packard said at roughly the same time of the year in 2014 that it planned to split into two companies, and now there are Hewlett Packard Enterprise Co. (NYSE: HPE) for servers and enterprise services and HP Inc. (NYSE: HPQ) for personal computers, printers and related products. HP lost thousands of jobs over the course of that restructuring. HP acquired Compaq in a deal worth $25 billion or so nearly two decades ago, and the deal was frequently touted as a bad transaction that did not add what was hoped.

Will IBM Have Difficult Earnings Ahead?

IBM did offer preliminary guidance with its split-up announcement. The company now sees revenue of $17.6 billion, with adjusted earnings of $2.58 per share and with GAAP earnings of $1.89 per share. While those figures are preliminary and may be subject to change, Refinitiv had estimates at $17.54 billion in revenues and $2.58 in adjusted operating earnings per share.

As the IT service operation has shrunk over time, does this mean that even IBM’s hybrid cloud and strategic imperatives are seeing sluggish growth now too? And what will this do IBM’s continual dividend growth?

How to Divvy Up the Cash, Debt and Goodwill

IBM still manages to generate massive cash, but the post-Red Hat merger has left it with a mountain of debt that must be properly divided. IBM’s long-term debt was $35.6 billion at the end of 2018, but it was $58.0 billion by the end of 2019 and was $59.1 billion as of June 30, 2020.

As of June 30, 2020, IBM had $14.3 billion of cash on hand, including its marketable securities. The company’s total debt, including its global financing debt of $21.9 billion, was listed as $64.7 billion at the time.

Standard & Poor’s immediately affirmed IBM’s A credit rating on this news and telegraphed that IBM will incur cash restructuring costs of roughly $900 million in 2020, followed by roughly $2.3 billion in 2021. S&P also sees one-time cash charges of about $1.5 billion related to the spin-off during the second half of 2021. While that is still investment grade, S&P has a negative outlook on that rating.

While the NewCo must hold on to a lot of the debt, it would not be fair for the remaining hybrid cloud IBM to go with very low debt, considering the Red Hat buyout and considering its dozens of smaller mergers. IBM even carried $72.1 billion in goodwill and other intangible assets as of June 30. That is nearly half of the value of all IBM’s $154.2 billion in assets.

Will Growth Be Interrupted?

IBM’s revenue shrinkage over time has been hard to ignore. The services shrinkage has been very evident, but will this restructuring and the aftermath of the COVID-19 recession strain an already difficult situation? Refinitiv already was calling for revenue to contract 4% to $74 billion in 2020 as is, and the consensus was looking for less than 2% growth to $75.2 billion in 2021 revenues. With 2019 revenues at $77.1 billion, IBM’s total revenues held basically flat with $79 billion-plus reports from 2016 through 2018.

Backing out Red Hat’s old revenues makes the scenario at IBM look more painful. Red Hat’s total 2018 revenue (ending February 28, 2019) was $3.4 billion. Red Hat’s standalone report at that time listed year-end deferred revenue as $3.0 billion, with a total backlog of more than $4.1 billion.

Despite all the opportunities for growth, all the strategic imperatives combined just could not escape the event horizon of the perpetual shrinkage taking place in NewCo’s services operation.

Will IBM Be Ejected From the Dow?

IBM is now among the older Dow Jones industrial average members. The company became a Dow stock in 1979, and now many other technology companies are in the Dow. As a result of Apple’s recent stock split greatly lowering the top stock’s weighting in the price-weighted Dow index, Salesforce.com was added to the Dow.

It seems that carving up IBM’s NewCo services revenues and its hybrid cloud and strategic imperatives into a standalone entity should probably make IBM “less of a Dow stock.” The NewCo may continue shrinking, and the people who vote on future index members would rather move companies with better growth prospects and better trends in as replacements. Does this leave the door open for Amazon, Google, Facebook or other major technology giants to replace IBM in the Dow?

The end result here may look great for IBM, once the separation is closer to completion. IBM has a history of execution issues over time, and it is now under new leadership. Ginni Rometty and those in the new CEO and president roles will have their hands full. Breaking up is never easy, and this will be a disruptive and painful process for many of IBM’s long-term employees and for many of the people who have come in from acquisitions alike.

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