Which company can profit more with its head in the cloud?
IBM (NYSE:IBM) and Oracle (NYSE:ORCL) are mature tech companies looking to the cloud to help them orchestrate a comeback. Just this month, the head of IBM’s cloud division, Arvind Krishna, took over as CEO. Oracle, a company associated with database management software for much of its history, has made its own moves into the cloud.
However, the future of these tech stocks remains in question as both companies face stiff competition from Microsoft, Amazon, and numerous other enterprises trying to profit in the same competitive space. Whether IBM or Oracle produces higher returns will likely hinge on executive leadership and how well they can guide their companies to cloud success. Let’s take a closer look and see which might be the better buy right now.
Where IBM stands
IBM has reinvented itself many times since its founding over 100 years ago. Big Blue now wants to redefine itself as a cloud company. The purchase of cloud specialist Red Hat in the summer of 2019 for $34 billion solidified this commitment.
However, that move may have amounted to an “all in” bet on its future in the cloud. After subtracting liabilities from assets, the purchase left IBM with about $21 billion in equity. However, buying Red Hat took its long-term debt to about $54.1 billion, and its available cash down to $8.2 billion, severely limiting its options to potentially make other acquisitions.
Revenue also struggles to gain any positive traction at all. Of IBM’s five divisions, Cloud and Cognitive Software and Global Business Services were the only ones to see revenue gains in 2019.
Moreover, profit growth has long remained sluggish. Analysts forecast profits to drop by 0.5% this year only to rebound at a 7.8% rate in 2021. This slow growth could dampen much of the appeal of the forward P/E ratio, which stands at around 8.6.
That makes it easy to see why Krishna, who had previously headed the Cloud and Cognitive Software division at IBM, landed the CEO job. He takes over from Ginni Rometty, who had led the company since 2012. During Rometty’s tenure in the chief executive position, IBM stock fell by about 40%.
IBM DATA BY YCHARTS
Now, many hold out hope that Krishna’s time as CEO will lead to a turnaround. If so, he may follow the lead of Satya Nadella, the one-time head of Microsoft’s cloud division who later became CEO. He then led a transformation that saw Microsoft become a top cloud company and, at times, the largest company in the world by market cap.
Nadella’s success does not mean that IBM will repeat the same type of performance. Despite the massive growth in the cloud, the area remains highly competitive. Still, even a partial success could bolster IBM stock as it struggles to lift its multiple into the double digits.
The state of Oracle
Like IBM, Oracle has spent the last few years trying to redefine itself. Its pivot into the cloud may help as the fast-growing technology continues to attract interest from stock investors.
However, Oracle’s cloud transformation also faces turmoil from inside the company. Mark Hurd, the co-CEO who led the company’s transition into the cloud, passed away earlier this year. This has led to more uncertainty, as Cloud Services and License Support was the only one of Oracle’s four divisions to see revenue growth in the previous quarter. The balance sheet also appears light on equity and heavy on debt. The company’s $49.3 billion in long-term debt overshadows equity levels of about $14.9 billion.
Still, despite revenue struggles, analysts expect earnings to increase by 9.9% this year and 7.5% in fiscal 2021. Additionally, at a forward P/E ratio of around 12.3, Oracle stock offers a compelling value.
Oracle stock has also moved steadily higher over the decade. However, it lagged the S&P 500 and depended on costly share repurchases.
ORCL DATA BY YCHARTS
The question now is whether his successors will be able to maintain the stock price growth. Unlike IBM, Oracle has not indicated that any further changes in leadership will take place. Co-founder Larry Ellison remains the company’s CTO. Moreover, with Hurd’s passing, the CEO role now belongs solely to Safra Catz, who has served in this capacity since 2014. How the stock performs going forward will likely hinge on how well Oracle’s cloud division can succeed with the current leadership and without Mark Hurd’s influence.
IBM or Oracle?
Whether IBM or Oracle delivers higher returns over time likely hinges on the management now in place at each company. However, if forced to choose one, I would go with IBM.
As for Oracle, I expect it to remain steady, but I see little potential for the level of profit increases to accelerate significantly. Moreover, the dependence on buybacks for stock price growth will not play well. The fallout from reaction to the COVID-19 pandemic has led to many companies suspending share repurchases. That may make investors uneasy in the current trading environment regardless of whether Oracle follows suit.
I would discourage any assumptions that Krishna will succeed to the degree that Nadella did at Microsoft. Nonetheless, by making Krishna the head of the company, it telegraphs a strong commitment to the cloud. Moreover, Red Hat’s assets should ultimately serve IBM well. I see this as a formula that can improve earnings growth, and, possibly, multiple expansions for IBM stock over time.
MyWallSt operates a full disclosure policy. MyWallSt staff currently hold no positions in companies mentioned above. Read our full disclosure policy here.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. Will Healy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon and Microsoft and recommends the following options: long January 2021 $85 calls on Microsoft, short January 2021 $115 calls on Microsoft, short January 2022 $1940 calls on Amazon, and long January 2022 $1920 calls on Amazon. The Motley Fool has a disclosure policy.