International Business Machines Corporation (IBM) Earnings Call Transcript & Summary

Welcome and thank you for standing by. [Operator Instructions] Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now I will turn the meeting over to Ms. Patricia Murphy with IBM. Ma'am, you may begin.

Thank you, Amanda. I'm Patricia Murphy, Vice President of Investor Relations at IBM, and I want to thank you for joining us today on short notice. We're here to talk about an important announcement and initiatives for IBM. I'm here with Arvind Krishna, IBM's Chief Executive Officer; and Jim Kavanaugh, our Senior Vice President and CFO. Given the timing of the strategic announcement, we've also provided a view of our preliminary third quarter revenue and earnings per share in the press release issued earlier today. We're still working through the details, and these results are preliminary. And so we will provide a more comprehensive view during our earnings call on October 19. So we're limiting today's discussion to the more strategic announcement. During today's call, we'll make some forward-looking statements, and these statements involve factors that could cause actual results to differ. Information regarding these factors is in the company's filings with the SEC, which you can get from the SEC or from the IBM website. And with that, I'll turn the call over to Arvind.

Thanks, Patricia, and thanks to all of you to join us on short notice. Today is a landmark day for our company, and I'm pleased to speak with all of you first. We are redefining the future of IBM and where we will put our focus moving forward. When I first talked to you in April, I said I was focused on prioritizing growth. Specifically, I said our focus was on helping our clients on their journey to cloud and AI, winning the architectural battle in cloud with Red Hat and continually delighting our clients and delivering sustainable growth for our company. Today's announcement positions us to deliver on that commitment. Our actions will better serve the evolving needs of our clients, accelerate our hybrid cloud platform growth strategy and drive sustainable growth. Over the last few years, we have built the foundation to capitalize on the trillion-dollar hybrid cloud opportunity, and that foundation is solidly in place. The acquisition of Red Hat has established us as the leading hybrid cloud platform provider. Adoption is accelerating, and we are seeing an increase in demand for our platform and capabilities. With this acceleration in digital transformation, clients' needs are changing. They are purchasing and consuming infrastructure and application services in changing ways, increasingly driven by separate buying cycles, distinct selection criteria and different decision-makers. As a result, we have announced the separation of our Managed Infrastructure Services business via a tax-free spin-off. We're creating a new public company, initially called NewCo, we will get a name eventually, which will be entirely focused on managing and modernizing client-owned infrastructures. At IBM, we are sharpening our focus as a hybrid cloud platform and AI company. We'll advance our strategy to increase investments, both organic and inorganic, to bring innovations to market more quickly. And we are streamlining our operations for speed. These actions benefit our clients, our employees and our shareholders and place both IBM and NewCo on an improved growth trajectory. So we are creating 2 market-leading companies focused on what they do best. IBM is an innovation-based business, solving the world's most critical technology problems. We will be maniacally focused on being the best hybrid cloud platform and AI company, leveraging our leading open platform, our incumbency and our expertise to help clients with their digital transformations. With the strong foundation we have built and increased focus, IBM will deliver sustainable revenue growth. Meanwhile, NewCo will immediately be the world's leading managed infrastructure services provider. With $19 billion of revenue over the past year, it's twice the size of its nearest competitor. This will be a company with unparalleled expertise in managing the complex and mission-critical infrastructures of the world's most important businesses. NewCo will work with its clients to modernize their infrastructures with next-generation services and a focus on service delivery excellence. And the 2 companies will continue to share a strong bond through strategic partnerships. But as separate businesses, each can capitalize on their respective missions, creating value through focus. Both companies will have increased clarity and agility to focus on their own operating and financial models and greater freedom to partner with other providers. Both companies can better align their investments and capital allocations to their respective strategic focus areas, whether that's new market opportunities or operational priorities or shareholder returns. Ultimately, this will create immense value for clients but also for investors with an improved growth profile of both companies. Let me spend a few minutes on IBM's strategic focus, specifically hybrid cloud. Our clients find that an open hybrid cloud approach is 2.5x more valuable than relying on public cloud alone. A hybrid cloud approach leads to greater innovation, higher developer productivity, increased efficiency and a greater ability to meet regulatory and security needs. There are 2 dynamics that drive value: the percentage of workloads running in a cloud environment and the maturity of the platform. We have talked before about the workloads in public cloud. It will be no more than 25% by the end of this year. Why is that? Most of the workloads have been limited to greenfield cloud apps and lift and shift. But moving to public cloud isn't enough. To unlock more value, clients need to address their entire environment. This includes containerizing applications and changing their operating model by bringing Agile and DevSecOps into their IT estate and then fully replatforming applications onto an integrated hybrid cloud platform. The fact that hybrid cloud is a $1 trillion addressable market for IBM post spin is largely driven by the immense value that is unlocked for clients. 90% of enterprises already have hybrid environments, a combination of public and private. But 75% of the workloads are not in public cloud, with mission-critical work either on-prem or in private clouds. What's the inhibitor? Often it's compliance and security. 60% of the opportunity is in highly regulated industries like banking, government, telco and health care. And to address these fundamental client needs, we are focused on providing a hybrid cloud platform that's open, secure and highly managed, software that can leverage the platform and expertise to manage and derisk a journey to hybrid. We have built this foundation over the last few years. In the largest part of the opportunity, software and platforms, we acquired Red Hat. We containerized our software. And to unlock the value of our vast software portfolio, we launched our Cloud Pak. More recently, we acquired 2 companies, Spanugo and WDG Automation, that add key hybrid cloud and AI capabilities. And we also launched the Red Hat Marketplace. In the services space, we're all in on application modernization. We now have the largest Red Hat consulting practice, and we launched OpenShift Everywhere. In the infrastructure layer, we recently launched LinuxONE with OpenShift on Z and built an industry-specific cloud to help our financial services clients tackle the most stringent needs of their industry. This foundation provides tremendous value to our clients, really helping them realize the 2.5x additional value of hybrid cloud. With Red Hat, we have the most broadly adopted hybrid cloud platform. This was recognized in Forrester's latest Wave report, which named IBM's Red Hat as the leading platform by far for both developers and operators. Our platform allows clients to build once, run anywhere and provides clients with the broadest access to innovation through open source. Our full-stack capabilities, including software and IBM Z incumbency, leverage that platform. A key differentiator is our ability to meet clients where they are in terms of the IT choices they've made and then help them move along their cloud journey with our deep vertical expertise. With today's announcements, we'll have greater focus and flexibility to move faster, innovate more freely and invest in the future of our business. This represents an important shift in our business model. We will go from having over half our revenue in services to one where the majority will come from software and solutions. This puts us on a clear trajectory for accelerated revenue and profit growth post separation. One of the best indicators of progress is to look at the pace of client adoption. I'm happy to say we have made good headway. Clients are eager to tap into open source innovation, and many leading companies are leveraging our hybrid cloud platform: Bank of America leveraging our financial services cloud and our hybrid cloud platform; Verizon leveraging our hybrid cloud platform for their 5G networks and innovation; Schlumberger using our hybrid cloud platform for taking their deep vertical capabilities in oil and gas into many more markets and geographies. Many other clients, as you can see there, across telecom, energy, financials and many other industries are taking advantage of these capabilities. As of June, we had over 2,400 clients on our hybrid cloud platform, almost tripling if you look at the last 18 months to 24 months. Deal sizes are getting larger, number of Red Hat large deals more than doubling. GBS is driving adoption of the platform with over 200 engagements that leverage Red Hat. And we are expanding our partner network with more than 300 new partners added to IBM and Red Hat's hybrid cloud ecosystem. So let me spend a few minutes talking about our full-stack capabilities that leverage the open hybrid cloud platform. It starts with Linux. I think you'll all agree that Linux is the de facto operating system standard and market share leader. Red Hat Linux, along with Containers and Kubernetes, provides, the architectural foundation. OpenShift is our core product that captures the value and works with the entire range of clients' IT infrastructures: on-prem, public cloud, private cloud and, of course, our own Z and Power. Our infrastructure is designed for the most critical and highly regulated workloads but leverages open source innovation. Moving up the stack, IBM's Middleware portfolio has been containerized. Our family of Cloud Paks extends capabilities with cloud-ready open software packages integrated on OpenShift. This means clients can now deploy our software anywhere OpenShift runs. OpenShift saves time and promotes scalability by enabling consistent development, security and operational flexibility to develop and consume software in a new way. We uniquely meet clients where they are. And with GBS' deep industry expertise, we help clients on their journey, whether that's modernizing and migrating applications, building cloud-native apps or managing these applications in a hybrid cloud environment. The value of our platform increases with adoption. And we are building a large ecosystem of partners, both best-of-breed ISVs and major system integrators. Now the economics of a platform approach are compelling. Every dollar spent on the platform creates additional value above and below. A lot of investor focus is on the infrastructure providers. They do generate $1 to $2 for every dollar spent on the platform. But a lot of value is generated above the platform layer. Another $3 to $5 is spent on software, and another $6 to $8 on the cloud services. This, of course, is shared by IBM and our ecosystem partners. So everyone wins, helping to lift all boats. The ecosystem provides fuel to expand our reach and accelerate adoptions. These are just a subset of the partners that are working with us. You've seen us talk about many of these in the past, and we'll continue to talk about more of them in the future. A number of them were present at our large user conference, Think that was held last May. And you can see, this combination of both independent software vendors and system integrators and many of the most important players in the industry provides the fuel to the platform. So today's announcement accelerates our hybrid cloud platform growth strategy through focus. Having a clear focus is important, but I know it's only part of our journey. To bring our ambitions to life, we are also relentlessly pushing forward on the creation of a culture that fosters learning, radical candor, curiosity, speed, innovation. This is what I call a growth and entrepreneurial mindset. At the same time, we're taking actions to simplify and optimize our operating model for speed and growth. This includes streamlining our geographic model, transforming how we go to market that allows us to better engage with and support our clients. And we will continue to consolidate our shared services model. As we execute these structural actions, we expect to take a charge of $2.3 billion by the end of the year. The savings from these actions will increase our financial flexibility, and we will reinvest them to accelerate future growth. We'll make prudent acquisitions and increase our level of organic investment in technology to add critical skills and expertise and to expand our ecosystem. Our investment will be concentrated in areas that create value for our clients: hybrid cloud, data and AI, security and emerging technologies like Quantum. The end game is accelerated growth. With a growth mindset going all-in on hybrid cloud and AI and increased investments, we expect to drive sustainable mid-single-digit revenue growth over the medium term. Let me spend a few minutes on NewCo. It's already a market leader in scale and capabilities. It will be laser-focused on client-owned infrastructure, with a comprehensive end-to-end portfolio from traditional services like hosting and networking services to transformational services of infrastructure modernization and hybrid multi-cloud management. This is a business where scale matters. NewCo has a $60 billion services backlog. It already serves more than 4,600 clients, including 75% of the Fortune 100. Its global reach spans 115 countries and includes 90,000 talented employees who have deep expertise across industries while doing important technology-intensive work. NewCo will build on its core strengths, managing complex and mission-critical infrastructures with the highest level of service delivery and reliability. It has a unique operational footprint with a strong multi-local presence and a comprehensive base of technology-intensive and highly regulated clients. It has differentiated capabilities to meet their clients where they are. As a stand-alone company, NewCo management will be able to build a more efficient operating model focused on service delivery excellence. NewCo will have greater agility to invest in the next generation of transformational infrastructure services that will extend its leadership. I mentioned earlier that client needs are diverging. NewCo will have full autonomy when it comes to adapting its go-to-market strategy that positions itself closer to its markets and infrastructure services customers. NewCo will be able to forge tighter alliances with cloud vendors and other providers that expands its ecosystem. All this will contribute to improved margin, profit and cash generation for NewCo. Now let me turn it over to Jim. He'll provide a lot more detail on the profile of the 2 companies and the transaction details.

Thank you, Arvind. We're all obviously excited about today's announcement around the acceleration of our hybrid cloud growth strategy. By establishing these 2 market-leading companies, we're creating value through focus, which is what today is all about. Let me provide more detail on the scope of these businesses and their capital structures. And for this audience, I'll put the scope in the context of today's segments. For NewCo. The managed infrastructure services capabilities Arvind just described are within our Global Technology Services business. And to be more specific, it's infrastructure services without the IBM Public Cloud. Post separation, IBM will consist of what's in today's Cloud & Cognitive Software, Global Business Services, Systems and Global Financing segments. It will also include the infrastructure capabilities aligned to our hybrid cloud platform strategy. That's IBM Cloud and the support services for our Systems businesses, both of which today are in Global Technology Services. We talk a lot on this call about the value of focus. IBM is focused on innovation and acceleration of our clients' digital transformations, while NewCo will be focused on infrastructure management and modernization and service delivery excellence. Each business will align its capital structure, investment profile and dividend policy to its respective strategic mission and financial model. At IBM, we will increase investment in hybrid cloud and AI to accelerate our growth while continuing to delever toward a ratio consistent with the single A credit rating. NewCo will be focused on operational efficiency and cash flow generation. While there's still work to do on the carve-out of financials, including the balance sheet and EBITDA, our objective is to establish NewCo as investment grade. The companies are initially expected to pay a combined quarterly dividend that is no less than our pre-spin dividend per share. Each company's dividend policy will obviously be determined by its respective Board of Directors. But that said, I expect IBM will remain committed to a secure dividend and a sustainable dividend growth policy. In terms of the transaction details, the separation is being executed as a spin-off to IBM shareholders which will be tax free for U.S. federal income tax purposes. We expect to close it by the end of next year, and it's subject to customary closing conditions. That includes the SEC Form 10 registration, a tax opinion from legal counsel and, of course, final approval from our Board of Directors. The transaction will result in onetime charges for items such as non-U.S. tax and activities associated with the separation and setup of an independent NewCo company. At this point, we expect to incur cash charges of about $1.5 billion and noncash charges of about $1 billion. Between now and the end of 2021, we got a lot of work ahead of us. We'll be preparing the financials for the new business and having them audited, filing the Form 10 and working through the public listing process while creating the structure and operations for this new entity. We will provide additional detail and information at the appropriate time, always in a form of transparency for you, our investors. In the meantime, we are operating as one IBM. So before going into the Q&A, let me summarize a few key points I hope you take away. We have built a solid foundation of hybrid cloud platform and AI capabilities. We're all in on hybrid cloud platform strategy, increasing focus and investments to accelerate our performance. And we're creating 2 market leaders with distinct strategies and value propositions. This is a win for our clients, our employees and our shareholders. Now I'll turn it over to Patricia to begin the Q&A session.

Thanks, Jim. As I mentioned upfront, given our timing in the quarter, we'll focus on today's strategic announcements, and we'll address questions on the third quarter during our earnings call on October 19. And as always, in the interest of time, I'd ask you to refrain from multipart questions. So Amanda, let me turn it over to you for -- to open it up for questions.

[Operator Instructions] Our first question comes from Wamsi Mohan with Bank of America.

Yes. Arvind, IBM has been focused on the integrated model for a very long time, and this is a huge step away from that model. How should investors think about how you're viewing the portfolio? Is this just a first step in a larger portfolio reconstitution? And can you help us think through the considerations on deciding what was it that made this business make the most sense to spin off at this time?

So Wamsi, thank you for the question, and it's always good to talk to you. So I would characterize it a little bit differently, Wamsi, than you asked. I believe we are still committed to the integrated model. If we look at our integrated model, it has always been in service of our clients against the technologies and solutions that we provide to our clients. So we're still providing infrastructure, software services against the portfolio that is important to us, which is hybrid cloud and AI. By the way, if I look at history, I mean, many people forget we divested networking back in the '90s, we divested PCs back in the 2000s, we divested semiconductors about 5 years ago because all of them didn't necessarily play into the integrated value proposition and clients could get them from other places without losing any value. So I would assert we are strongly committed to our integrated model. However, the integrated model is against the value of the technology and the solutions that we provide to our clients. And so we believe our clients need a lot of services on their journey to cloud, and that is the portion of services that we are keeping in the company.

Thank you, Wamsi.

Our next question comes from Katy Hubert (sic) [ Katy Huberty ] with Morgan Stanley.

Arvind, congratulations on making this step, an important move towards returning to revenue growth. I want to ask a question, and maybe this is more geared towards Jim, about the potential revenue and cost synergies given the historical integration of IBM business units. And also, what commitments will IBM and NewCo make to each other in terms of cross-selling products and services? And will those commitments be specific in terms of time line and dollar amount over time?

Katy, maybe I'll just start for 30 seconds and then give it to Jim. Look, I'll say very briefly that IBM and NewCo will have strategic partnerships with each other. We have a lot of work to do ahead of us, so I want to be clear about that. But at first glance, it looks like we will be either each other's largest customers or very close to that. The tone and attitude we should take always is to do this in a way that is beneficial for both companies as opposed to trying to force people into certain constructs and contracts. But with that, let me give it over to Jim because it's an important question, as you can believe, we have worked over and will continue to work.

Yes. I mean as we talked about today, today is all about really going all in, in aligning our portfolio, our operating model, our capital investment allocation and our financial investment thesis around creating 2 leading -- market-leading, independent companies that will do what they do best and solve mission-critical workloads for our clients and deliver value. The IBM company will be focused on accelerating the adoption of hybrid cloud platform and AI solutions. And you saw, as Arvind took you through that platform economic chart, about how all the components of our integrated model fit together. There is a multiplier effect that delivers substantial revenue leverage and synergistic value of the IBM company that we are creating going forward. It's a flywheel effect of that multiplier. And NewCo, being a market-leading company day 1, with a very strong client base, unrivaled client base, and a market opportunity of about $0.5 trillion, has a tremendous opportunity to go deliver value, improve revenue growth profile but deliver substantial margin, EBITDA growth and EBITDA value over time. Around your question around stranded costs, yes, obviously we've been running the company as an integrated company for decades. There will be a manageable amount of stranded costs. But as you saw and you heard from Arvind, we are taking structural actions to address those stranded costs, $2.3 billion by the end of the fourth quarter. And I would say that those structural actions are being aligned to reposition both companies: first, to enable a NewCo on an improved EBITDA growth profile with double-digit EBITDA margins; second, to address those stranded costs, which we're going to be able to take care of; and third, most importantly, enable significant financial flexibility to enable us to invest both organically and inorganically to deliver that revenue growth profile that we talked about.

Thank you, Katy.

Our next question comes from Toni Sacconaghi with Bernstein.

Yes. I just have a couple clarifications. So there will be $2.3 billion in restructuring actions. And are those cash? And then there's an additional $2.5 billion to close the deal? That's the first clarification. Second, can you comment on how much hardware and software annually is sold via outsourcing deals today? And then thirdly, Arvind, you talked about mid-single-digit growth going forward. Maybe you could just paint a path on how you get there. You're spinning out about 1/4 of the company's revenues that are declining 4%, 5% a year. That will help your revenue growth about 1 point. So what's the path to mid-single-digit growth when you're sort of flat to down over the last couple of years and the spinout just mathematically will maybe add 1 point? That'd be helpful.

So Toni, why don't I take the last part of your question and then I'll hand it to Jim for your first 2 parts? I think it was a 3-part question if I'm right.

2 or 3.

So in terms of, let's call it, deconstructing the growth profile for IBM, I think we can first take Red Hat and say that Red Hat has contributed significant growth and will continue to contribute growth going forward. That's part 1. Part 2, you heard us mention both organic, which means increased R&D, as well as acquisition investments that will improve our software growth portfolio. You could see it from the past 3 years or 4 years, how long you want to take it, profile of that business. Three, we talked about increased investments in the ecosystem. That means how we go to market with Adobe, with Salesforce, with Box, with Slack, with Schlumberger, with many others that we have just announced over the past, I'll say, whether a month or 2 years, and others going forward. So we're going to put significant investment into that. That's the third part. And fourth, we will improve both our skills investment into Global Business Services as well as inorganic actions in there to improve the growth profile. So if you deconstruct it, that's how we are going to return to mid-single-digit growth sustainably because what I described is not a onetime. That is what we intend to keep doing as we improve the growth profile and make it sustainable in the medium term. Jim?

Yes. Toni, thanks for the question. Just from a clarification perspective, yes, first, we expect to take a $2.3 billion structural action in the fourth quarter. And as I stated earlier to Katy's question, this is really centered around positioning NewCo to have solid EBITDA growth profile moving forward and address stranded costs and also to enable significant financial flexibility to enable investment -- reinvestment back into our company to accelerate that growth profile Arvind just talked about. The transaction-related charges, which is $1.5 billion of cash-related charges that we expect, obviously we have a lot of work to do to carve out this business, set up the balance sheet, the capital structure, and this will play out over time. And we also expect about $1 billion of noncash charges. And that would encompass, as you would expect, non-U.S. tax in regulatory areas; IT setup costs to set up an independent, viable company; severance in many areas around the world that are required legally; retention costs of our critical, key skills to ensure stability of our client transitions; and also some minor pension settlements and transaction fees over time. So $2.5 billion of a -- or excuse me, $2.3 billion of a structural action in the fourth quarter that's positioning how we set the future for success for both companies, and then transaction-related charges of $1.5 billion cash, $1 billion noncash.

Thanks, Toni.

Our next question comes from Matt Cabral with Crédit Suisse.

I was wondering if you could help walk through what will be remaining within the GTS portfolio after the transaction and how that fits within your strategic direction going forward. And then I heard $19 billion of revenue for the managed infrastructure business. I'm just wondering if you could comment on what the PTI and free cash flow profile looks like for NewCo at this point.

So Matt, let me just start and then I'll give it to Jim for the second part of your question. We're taking out our Managed Infrastructure Services. If you think about that, that's our infrastructure services that contain both outsourcing and what is called ITS, Information Technology Services, where we do project-based work for our clients but on their -- mostly on their on-premises infrastructure. So that's the nature of the businesses that are being spun out. You heard me talk about the traditional services, both hosting and networking services, but also services around storage and data management as they help their clients towards some of the devices in IoT, et cetera. That's the nature of what is being spun out. In terms of the -- some of the financials, we pointed to what it will be, and that's some of the work we are doing between now and the regulatory filings, but I'll let Jim comment on that a bit more.

Yes, Arvind. Matt, thank you for the question overall. But as Arvind just stated, we've got a lot of work to do ahead of us right now in carving out this business, setting up the balance sheet, the capital structure, which we fully expect to drive an investment-grade company going forward. $19 billion trailing 12 months, Arvind talked about what's included in that. We do expect an improving growth profile of that business going forward, and we do expect -- just given the structural actions we're taking in the fourth quarter combined with NewCo being independent and not carrying the burden of the overhead structure that ultimately is a stranded cost on the IBM equation that we are going to address through that structural action. So they'll be leaner, they'll be -- have more agility to move and operate in their model. But it's too early right now to give you specificity about what their pretax income, operating margins are, free cash flow. But we expect a company that's going to have an improving margin profile, expect it to deliver double-digit EBITDA margins pretty consistent with its peers', a solid balance sheet, enable a targeted investment-grade rating and a free cash flow yield in line with its peers and a strong dividend yield which will be very attractive to value-based investors.

Thank you, Matt.

Our next question comes from Tien-Tsin Huang with JPMorgan.

Arvind, I appreciate your comments on culture and growth here. I was hoping -- maybe just elaborate quickly just a little bit more on the key initiatives around the $2.3 billion charge. Beyond costs here, how much of this is about modernizing your sales and your go-to-market model? I mean I heard you mention your sales model and geo alignment, et cetera. So maybe if you can elaborate on that. And then separately, can we expect IBM to remain acquisitive here in the short term?

Look -- Tien-Tsin, thanks for the question. First, let me -- yes, you can expect IBM to remain acquisitive. We have made a couple of, I'll call them, small acquisitions in the past few months. You've seen us do that. But as some of the FINFLEX opens up with respect to how we begin to deploy both the cost savings we're doing and as we deleverage, to the point that Jim made, that opens up our flexibility to do, I'll call it, appropriate acquisitions. So I don't want to be focused on small or large. We will do appropriate acquisitions that help drive our growth. We believe we actually have the flexibility to get those done as we look at what will happen both over this coming quarter and into next year and the years after. So I'll put that to the side. The next question you had in terms of what kind of things are we doing, so there's probably already news out there. We are simplifying our geography model. We used to function as 7 geographies. We have already simplified down to 4. You should expect that as we form into both the new IBM and NewCo, then the new IBM gets further opportunities to keep simplifying the geography structures, and that provides greater flexibility in terms of speed of decision-making as well as -- there is, but it's a consequence, not the primary reason. It will result in increased efficiency as you take out layers because it's a simplified operating model with a much clearer focus on only hybrid cloud and AI. We're also going to be investing in our ecosystem. That means more business partners, more working with partners, investing in how the -- those partners come on to our platforms. That will be investments we will make. But as we do that and the return comes as they deploy their platforms, then our platforms come along together with that. In some cases, we'll create joint go-to-markets in some of those cases. Those are just really quick examples, Tien-Tsin, in terms of how some of the savings from that $2.3 billion will get reinvested. By the way, as I laid that out, that's probably only 1/3 of the reinvestment. The other 2/3 is going to come in terms of increased innovation, it's going to come in increased skills for our services business, et cetera. So a lot of that is in areas where we believe that, that innovation will result in much more client delight. And it does take a couple of years to pay off, so I want to be cautious about the return time frame. But with that will come increasing and accelerating growth.

Thank you, Tien-Tsin.

Our next question comes from Amit Daryanani with Evercore.

Yes. Congratulations on the announcement, by the way. I guess, Arvind, when I think about the medium-term target that you talked about, I think mid-single-digit organic growth, I'm curious, what would that target be had you not done the spin-off of the GTS assets? And I guess somewhat related to that, I think this announcement will really drive more discussion or speculation on if you would look to spin off other assets as well as you go down this journey of further streamlining your portfolio. So I'd just love to understand, what drove the process to spin off these assets versus GBS or the hardware business that one could argue is not as core to the hybrid narrative either? So I'd just love to understand how you came about these assets versus others.

Okay. Thanks for the question, Amit. So let's talk about a little bit. So I think to address your question straight on, we don't expect to take any more significant structural actions. There may be some cleanup on the edges, but there is nothing more to come. So let's just address that right away and sort of take that off the table. We've always done, I'll call it, minor portfolio optimization. You've seen us do it over the years. That's not going to change. I'll talk again in a moment about our growth profile. We stated clearly mid-single-digit growth over the medium term. So without getting into that because you threw a couple of other words in there that's not in our phrasing, so I'll sort of leave that out, it's hard to tell you what it would be if we hadn't done this. We're doing this in order to unlock growth and in order to accelerate value. And if I look at our integrated value proposition, our integrated value provision says I want to take advantage of the incumbency of clients running mission-critical workloads. Our mainframe and our software portfolio is where they tend to do that. We then take advantage of the hybrid cloud platform to take them from where they are to where they want to go. Many of them will need help on that journey, and hence, our GBS portfolio helps our clients along that journey. I think that is why those pieces stay together. By the way, there is -- would be tremendous dis-synergy if we try to take hardware and software apart. When we look at the way those deals are structured, when we look at clients often taking advantage of both sides of their portfolio, it may not be all clients, but it is enough that there will be significant dis-synergy if we try to take those apart. So that explains why we kept all these things together, and that is kind of the journey we have been on. And by the way, this -- I would tell you that we began our hybrid cloud journey many years ago. We took a big, bold step when we acquired Red Hat, and we made that announcement about 2 years ago, 23 months and a few days, but who's counting, from -- before today. The last 2 years gave us the confidence that, that platform was both accelerating and our clients were embracing it. That's allowed us to take this bold step today in terms of this announcement. So I would tell you that this is all part of our plan to get to this point, and this is where you should expect us to deliver sustainable growth going forward.

Thank you, Amit.

Our next question comes from Jim Suva with Citigroup Investment Research.

And your details have been extremely useful. If I remember in the past, when IBM has done some pruning and repositioning for growth and things like that, whether it be getting rid of servers or PCs or semiconductors or the call center business, I believe they were mostly sales and not tax-free spin-offs. So what's changed now to cause you to do the tax-free spin-off? Is it the market valuations? Is it something different? Because it seems like that this action is a little bit different than from the past portfolio repositionings that IBM has done in the past.

Yes. Thanks, Jim, for the question. I'll take this one, Arvind. We obviously have come to this decision based on everything we talked about here today about how we align both companies as independent and viable and strategically focused on what we do best here overall. A spin affords us more control over what I'd call the critical value drivers: that's scope; that's management team; that's capital structure; that's tax advantage to our shareholders, which is very important. But also, just as important is how we manage the transition with our clients overall. A spin also offers shareholders the opportunity to participate in the upside of value creation, which we firmly believe will come out of this with 2 very focused companies, industry market-leading companies overall. And to your question, yes, we've used alternative structures throughout the history of IBM overall. But I would just venture to say that a spin also affords us optionality, and we can pivot to a sale if qualified buyers emerge. We're always going to look at what's the best thing for our investors, our clients, our company and our employees, and we'll take that approach as we go forward.

Thank you, Jim.

Our next question is from Keith Bachman with Bank of Montreal.

And Jim and Arvind, I think this is certainly a positive step in the journey for IBM. And my question relates to that word, journey. And Arvind, I'm just, a, surprised that you're suggesting that there's not more scope or more trimming that you could do. Jim just used the word scope and management structure and things along those lines. And so for instance, if I look at GBS, one of the areas that we've called out is application management is still declining in mid-single digits. It's a pretty tough business. I'm just surprised there's not more scrutiny associated with perhaps incremental trimming. And then, b, if you could talk about M&A a little bit. Your recent deals have been -- given your revenue base, frankly, they don't really have a meaningful impact. Red Hat was a big deal, but you're still carrying quite a burden of debt. And so I'm just wondering what the trigger is that would allow you to make more meaningful M&A. And in particular, why be constrained by a rating rather than perhaps even taking on a little more debt to complete more meaningful M&A? That's it for me.

Keith, I'll start. And then also, if there's portions left, Jim can add on. This is -- look, our decision-making is not based on what's declining or what's not declining. Our decision-making is based on looking at what clients value, looking at what is strategically important, looking at what both feeds that strategy, provides fuel to that strategy and allows us to give even more value to our clients. That is what defines that. So all the areas where we might have incumbency, that feed us into going and taking our clients on a hybrid cloud journey, all the areas that are critical to our clients on that is what we are keeping. And that's why you heard me say that, yes, there may be portfolio trimming at the edges but nothing that is substantial today. Okay. So having said that, then you asked about M&A and investment-grade ratings. So Jim was clear that we are in a process of deleveraging and we'll be getting back to our prior ratios within a short period of time. Whether short is 1 year, 2 years in that period, we have committed to that in the past. We are not tying ourselves to that. If there is appropriate things, we'll go look at them always. And we've always said we have the FINFLEX to be able to look at things, and we are not tying ourselves to any particular ratio on that front. We do believe that this opens up the flexibility of the company. It'll be a higher-margin company going forward, and that allows us more flexibility as time progresses. So that's sort of my answer to both those questions. I don't think you should view that we are tying ourselves down in a way that constrains us going forward in the short or medium term.

Yes, David (sic) [ Keith ], just to build on what Arvind said, this strategic focus of aligning 2 market-leading companies right now, around IBM, it's around purpose, clarity, to deliver value, win the architectural war and be the undisputed leader in hybrid cloud and AI. With that, we believe, just given the market growth opportunity of a $1 trillion TAM, that we have a great opportunity to accelerate growth with already very strong EBITDA margins. What does that provide then? After we take our structural actions and continue reposition the -- repositioning this business, we will have ample cash and tremendous financial flexibility to invest back in our business. I've always said we have a very disciplined capital allocation structure policy in this company. It starts with enabling the investments in our business to grow and deliver value to our clients and shareholders. It then is focused on delevering to maintain an investment-grade profile, which we believe is important because of the third piece which is our return to shareholder program, which is focused on securing IBM's dividend and a sustainable dividend growth policy given the investor mix of our business today. And we feel very confident in the strength of our balance sheet, the cash generation of this business accelerating going forward, that we will have ample opportunity to really attack each of those 3 components of our capital allocation strategy.

Thanks, Jim. And Keith, thanks again for the question. So let me wrap up by making a few short remarks. As I said at the beginning of the call, today is a landmark day for our company. We are redefining the future of IBM and where we'll be putting our focus moving forward. We said we were focused on growth. So we are creating 2 market-leading companies, each focused on what they do best. IBM is an innovation-based business solving the world's most critical technology problems. We will be maniacally focused on being the best hybrid cloud platform and AI company, leveraging our leading open platform. With the strong foundation we have built and the increased focus that you heard both me and Jim talk about, IBM will deliver sustainable revenue growth. The second company, NewCo, will immediately be the world's leading managed infrastructure services provider. With $19 billion of revenue over the last year, it's twice the size of its nearest competitor. The 2 companies will continue to share a strong bond through a strategic partnership. We are confident in the road map we have laid out. We are confident in delivering the sustainable growth as we execute post spin. Thank you all for listening.

Amanda, let me turn it back to you to end the call.

Thank you. And thank you for participating on today's call. The conference has now ended. You may disconnect at this time.