IBM's Cloud, Analytics Moves Haven't Paid Off, Yet

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Giant corporations and supertankers have one thing in common: They do not respond very quickly to a change of course.

IBM, one of the biggest supertankers in tech, as well as corporate America, is still in the middle of its turn, posting its 13th quarterly decline in revenue during this week's quarterly financial report. The second quarter marked a continuing drop in hardware and software sales, but rapid growth in cloud computing services and data analytics.

The big question for Big Blue is: Will it succeed in changing course?

"Today, the bears are winning," said Bill Kreher, a technology analyst with St. Louis-based investment firm Edward Jones.

"Long term, the company (IBM) is putting itself in a position to grow again," Kreher told InformationWeek. "Near term, they are expanding profit margins as they shed lower-margin businesses … They are going to have lumpy results for the next few quarters."

Waiting on a Turnaround

Kreher expects to see an "inflection" in 2016, as IBM's "strategic initiatives" like cloud computing and data analytics really hit stride and exceed the performance of declining legacy divisions, which he viewed as "empty calories."

"The company made some large bets on these businesses," Kreher said. "They have to grow, regardless." IBM understands their legacy units will be cannibalized by the growth in cloud computing, so it is better that IBM do this rather than competitors, he noted.

What constitutes a turnaround at IBM?

"You'll know it when you see it," said Martin Wolf, head of California-based Martin Wolf Securities. "IBM has been fighting the tape for years." He declined to put a date on any prospective turnaround.

Some of IBM's "strategic initiatives" efforts rely on acquiring technology through the buyout of smaller firms possessing the right technology. But these acquisitions can be pricey, have "small bases, growth, and high profits, but they are dwarfed by legacy businesses that are not doing very good," Wolf noted.

"They [IBM] are pushing a rock uphill, two-steps forward and three steps back," Wolf added. "IBM [still] has great client relationships. It is a trusted global brand. But the business model is too complicated."

The company cannot grow by cutting costs or through continued "financial engineering." It may take more restructuring, maybe the arrival of an activist investor on the board or even an outsider being brought into principal leadership to signal a true turnaround, Wolf said. "Then I think it will get interesting."

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One hopeful sign has been the slight growth in gross margins, up from 50.7% to 50.9% -- "just enough to get the check," Kreher said. But cash flow has been hobbled by declining revenues. "Software was the culprit here," Kreher said. Thick licensing revenues are dropping faster than thinner subscription revenues from cloud services can increase.

Mixed Results

The July 20 numbers bore this out. Second quarter revenues were down 13.5% to $20.81 billion. (Wall Street analysts were expecting $20.9 billion.) Profit dropped 16.6% to $3.45 billion.

This marked the 13th consecutive quarter for dropping revenue.

The cloud proved to be the silver lining in IBM's recent performance.

Cloud computing revenues were up 50%, producing $8.7 billion over the past 12 months. Data analytics revenue was also up 20%. These two efforts are part of IBM's "strategic initiatives" -- growth markets IBM wants to ride to achieve turnaround.

But are these new lines of business growing fast enough to make up for the declines in legacy markets? The Technology services division was down 12%. Software dropped 10%. Hardware revenue was down 32%.

Maybe the only bright side in legacy was the mainframe unit.

This product line still generates 25% of revenue and 35% of profit at IBM. The launch of the new z13 mainframe kicked mainframe sales up 9% in the second quarter, but again, not enough to stem the overall drop in corporate numbers, according to press reports.