IBM's First Quarter: Where's The Growth?

Big Blue might need to further cut costs to meet earnings goals as its top line sputters, but customers could suffer if it's too aggressive.
9 Startups To Watch In 2012
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IBM on Tuesday reported anemic revenue gains, as sales grew less than 1% compared to the previous quarter. The tepid results mean the company could be under pressure to cut costs to meet aggressive earnings targets in an environment where IT spending has slowed in key sectors.

Big Blue's total revenue for the quarter came in at $24.7 billion, below analysts' estimates. The miss had IBM shares off by more than 2% in trading early Wednesday.

The quarter did contain several upsides for IBM. Net income was up 7.1% year-over-year, to $3.1 billion, and earnings per share increased 13%, to $2.61. IBM also posted solid revenue gains in areas that it has identified as strategic, such as Smarter Planet (up 25%), analytics (up 14%), and cloud computing (up 100%).

The problem is that those are nebulous categories to which IBM can assign numerous combinations of sales wins to make the numbers look rosy. The situation isn't so bright in real reporting segments for which IBM has to state real numbers--not just percentage gains.

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Software revenues were up 5% to $5.6 billion, but hardware sales fell 7% to $3.7 billion. Mainframe sales in particular were off, by 25%. IBM will be counting on its newly announced PureSystems private cloud servers to boost hardware revenue going forward.

In IBM's Global Services unit, IT outsourcing sales, which account for more than one-third of the company's revenue, were up just 2%, to $10 billion, partly offset by a 2% decline in sales of business operations and consulting services.

Weak public sector demand in the U.S. and a slowdown in Europe and Japan, which is still recovering from last year's tsunami, were partly to blame for IBM's flat top line. Big Blue wasn't alone in feeling the pinch. Intel said Tuesday that quarterly sales grew just .5%.

IBM's problem is that it has publicly committed to delivering earnings per share of $20 by 2015. To fulfill that promise it will have to grow EPS more than 11% annually over the next four years, in a slow-growth environment.

That means the company will have to continue to cut costs, but it has already plucked the low-hanging fruit. It has off-shored and automated considerable portions of its operations while trimming U.S. headcount to reduce expenses. Internally, CIO Jeanette Horan is moving key infrastructure, including testing, storage, and desktop, to the cloud, which should save additional cash.

But if its top line doesn't pick up, the question becomes whether the company can continue to cut in order to meet EPS targets without damaging customer relationships. "Investors sometimes question can you continue to grow EPS when revenue growth is so much lower," Sanford C. Bernstein & Co. analyst Toni Sacconaghi told Bloomberg. "At some point, you're going to run out of cost improvements."

There are signs that some of IBM's operations might already be redlining under the pressure to meet margin goals. Officials at Texas utility Austin Energy blamed IBM's failure to perform on a BPO contract in part on the company's margin hunt. IBM also reportedly lost a lucrative outsourcing deal with Disney earlier this year when the entertainment giant handed the engagement to India's HCL Technologies.

The challenge for IBM CEO Ginni Rometty, in her first year at the helm, will be to maintain IBM's profits in a difficult IT spending environment, without disrupting customer services. Rometty didn't make her life any easier when, on Tuesday, she raised IBM's full-year earnings guidance to $15 per share.

The pay-as-you go nature of the cloud makes ROI calculation seem easy. It’s not. Also in the new, all-digital Cloud Calculations InformationWeek supplement: Why infrastructure-as-a-service is a bad deal. (Free registration required.)