IBM's Fourth-Quarter Results Hold Promise, Pitfalls

IBM turned in better-than-expected fourth-quarter results this week. However, the numbers still show how far Big Blue has to go to return to profit and growth. When does the Street run out of patience?
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IoT 2016: 13 Hot Trends For Business
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Corporate turnarounds take years. Wall Street runs in quarters. The two won’t mesh. This is where IBM, once a darling of the Street, finds itself.

IBM is still mired in this swamp of contradiction. The company delivered slightly better-than-expected results for its fiscal fourth quarter, when the numbers were announced Jan. 19. However, the company also reported declines in revenues and profits year-over-year.

The new lines of business IBM is investing in, encompassed by the Strategic Imperatives label, grew robustly to make up 35% of its fourth-quarter revenues. However, growth here was not strong enough to offset the continued decline in Big Blue's legacy businesses.

This is not the first time IBM has found itself in this position.

In the 1990s, the company suffered a near-death experience when it mishandled changes in its organization and misperceived the growth of the PC market at the expense of mainframes.

The same thing happened in the 1960s, when the company exited tabulating and adding machines to get into mainframe computing, again suffering pain before gain.

Fortunately, the situation at IBM today is not as dire as its two previous periods of bloody change. Yet for the third time in about 60 years IBM finds itself trying to shed its past to seize its future.

First, the Numbers

The good news is that IBM's fourth quarter numbers did beat analysts' expectations -- slightly. Quarterly earnings clocked in at $4.5 billion on revenue of $22.1 billion. Stated as earnings per share, IBM's profit was $4.84 compared to the expected $4.81. Revenue was also slightly better than expected -- $22.1 billion instead of the forecasted $22.04 billion.

However, every business segment showed year-over-year decline for the same quarter. Global Technology Services dropped 7.1% to $8.12 billion in sales. Global Business Services fell 9.9% to $4.3 billion in revenues. Software declined 10.7% to roughly $6.7 billion in sales.

In total, fourth quarter revenues were down 8.5% and pre-tax net income off by 28%. IBM's stock price stood at $121.85 at the start of business Thursday, Jan. 21.

However, most importantly to the company and the Street, the fourth quarter results mark the 15th consecutive quarter of declining revenues and earnings at IBM.

Patience …

IBM continues to stress growth in its Strategic Imperatives, consisting of big data, analytics, mobile, security, and cloud. These five lines of business totaled $29 billion, or roughly 35% of IBM's revenues, noted CFO Martin Schroeter.

Despite the lower year-over-year comparison, sales logged under Global Technology Services are up for the third straight quarter, said Schroeter. Cloud and hybrid cloud services contributed to the top line, as did Softlayer, IBM's platform-as-a-service (PaaS) product.

Analytics, up by 20%, and cloud services, up 60%, contributed to the top line of the Global Business Services segment. Again, the transition is ongoing as clients move towards analytics, cloud, and mobile, as Schroeter explained.

Software covers Watson, Watson Health, Internet of Things, and Bluemix, which are also showing growth under the Strategic Imperatives undertaking. While annuity content is reaching 70% of revenue in this segment, "transactional content" continues to decline, said Schroeter. Annuity content also encompasses software-as-a-service (SaaS) subscription and support.

SaaS as a percentage of overall Software revenue is pretty small. "[I]t's not going to drive a ton of the top-line, but over the long-term this will be a good economic model for IBM," said Schroeter during the Jan. 19 call with analysts.

History Repeats Itself?

Left unspoken is IBM's previous history with the pain of change. This is the third time in 65 years that Big Blue has had to reinvent itself.

In the early 1960s, then chairman Thomas J. Watson, Jr., essentially bet the company’s future on developing the System 360 mainframe line. This undertaking also made every IBM product obsolete when the System 360 debuted in 1964. IBM had many business units that didn’t talk to each other very well and all had vested interests to protect when Watson rammed through the System 360.

That effort took about 12 quarters before paying dividends.

The same bloodletting occurred again in the 1980s and 1990s after success led to complacency. Head count peaked at over 400,000 in 1986, being halved in just eight years as IBM restructured. By 1990, sales flattened and restructuring costs skyrocketed. It was Big Blue's last profitable year until the end of its fiscal year 1994. The fourth-quarter earnings that year were triple analysts' expectations. IBM embraced the PC revolution and had reinvented itself as a services company.

Once again, getting there took 12 quarters of grief.

[Read how design thinking is taking hold at IBM.]

Now, however, IBM has notched its 15th straight quarter of declining revenue -- almost one whole year more than the other problem periods.

"I don't know how many quarters of revenue decline (you can have) and have nothing happen," said Martin Wolf, head of Martin Wolf M&A Advisors of Walnut Creek, Calif.

Were it not for investor Warren Buffet patiently hanging on to his stake in IBM, others would be circling Big Blue. "It has to be broken up," Wolf told InformationWeek. "The business is too complicated to manage."

Since the time of chairman Watson and the System 360, IBM has been a one-stop shop for corporate customers seeking IT solutions. That meant selling everything from hardware to software and services, and everything in between. That also meant legacy units that generated revenue but resisted change.

"The benefit of young companies is they are not burdened by their baggage," Wolf explained. "They [IBM] have competition that can move quicker and has access to capital."

IBM would be an entirely different animal were it owned and run by a hedge fund, more focused on newer lines of business while rid of legacy units, Wolf opined. In the meantime, IBM can only try to create asset value out of its existing units.

This is taking years. Wall Street runs on quarters.