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International Business Machines Corp’s (IBM - Free Report) recent investor briefing reflected its continuing focus on being a cloud-first company. Notably, cloud revenues grew 35% to $13.7 billion for this Zacks Rank #3 (Hold) stock in 2016. You can see the complete list of today’s Zacks #1 (Strong Buy) Rank stocks here.

The annual exit run rate for cloud as-a-service revenue increased 53% on a year-over-year basis to $8.6 billion. Moreover, IBM had more than 50 cloud centers globally and its Bluemix platform was one of the largest open public cloud deployments worldwide at the end of 2016.

We note that the impressive growth has helped IBM outperform the S&P 500 in the last one year. While the stock has gained 18.1%, S&P increased 15.3% in the same period.



Cloud Computing: Robust Growth Expectations

We note that IBM’s growth expectations from cloud computing remains positive in the long haul. Management expects market opportunity in enterprise cloud to be greater than $800 billion by 2020. Moreover, the company anticipates more than 85% of enterprises to commit to multi-cloud architectures by 2018, which is positive for its hybrid cloud offerings.

As such, the overall growth expectation for the public cloud computing services market is very much bullish. According to Gartner, worldwide public cloud services market is projected to grow 18% over 2016 to $246.8 billion in 2017. Further, the figure will increase to $383.3 billion by 2020.

Infrastructure-as-a-Service (IaaS) is projected to be the highest growth service driven by improvement in PaaS and massive adoption of artificial intelligence (AI), analytics and the Internet of Things (IoT). IaaS is projected to grow from $25.29 billion in 2016 to $71.55 billion in 2020.

IBM Lags Behind in the Cloud

Despite the impressive growth figures and bullish sentiments, we note that IBM lags behind the likes of Amazon (AMZN - Free Report) and Microsoft (MSFT - Free Report) in the public PaaS and IaaS cloud computing markets.

According to Synergy Research’s latest report Amazon Web Services (AWS) maintained its dominant position in the market followed by Microsoft Azure, Alphabet’s (GOOGL - Free Report) Google and IBM at the end of fourth-quarter 2016.

The research firm noted that these three have gained market share in the last one year at the expense of smaller players as well as strong performance from Microsoft and Google. However, their combined market share of 23% lags a fare bit as compared with Amazon’s 40%.

We believe that IBM’s hybrid approach is yet to find many takers in both the public and private cloud markets. Despite significant investments – first on acquiring SoftLayer for $2 billion and then spending more than $1 billion on data centers – the clientele is not as impressive as Amazon or Microsoft.

China: IBM’s Savior?

Per Gartner, China has become a significant IaaS cloud market. The research firm noted that “While China's cloud service market is nascent and several years behind the U.S. and European markets, it is expected to maintain high levels of growth as digital transformation becomes more mainstream over the next five years.”

IBM is now planning to tap into China’s fast- growing cloud computing market through a new company formed in collaboration with Wanda Internet Technology Group. The new company will offer IaaS and Platform-as-a-Service (PaaS) to Chinese enterprises and businesses. Reportedly, IBM will have a share in revenues.

Moreover, as a part of the deal, the company will launch Watson services to China. IBM is expected to offer Watson Conversation services at the first, which will allow developers to add natural language interactions between applications and client.

Conclusion

Despite lagging in competition, we believe that IBM is developing a niche for its hybrid cloud services along with “Strategic Imperatives” (cognitive computing, Artificial Intelligence, Machine Learning).

IBM Watson on Cloud is a key growth driver in IoT, healthcare and financial services end-markets. IBM Watson is anticipated to reach more than 1 billion people by the end of 2017. Moreover, Blockchain initiatives, Quantum computing, Containers are some of the other catalysts that will support growth trajectory in the long run.

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