Is The IBM Turnaround Finally In Sight?

  • IBM reported its Q1 2016 results with higher than expected EPS and revenues.
  • Strategic imperatives’ revenue has grown, and the company made additional transformation actions and acquisitions in Q1.
  • Is a turnaround for IBM finally in sight?.

The tech giant, International Business Machines Corp. (NYSE:IBM), reported its Q1 2016 results on Monday with higher than expected topline and bottom-line figures. Analysts’ consensus for IBM results reflected a 7% YoY drop in revenues and 29% YoY decline in EPS. However, actual figures present only a 4.5% decline in revenues and an EPS surprise of 13% above the consensus. Like what happened last quarter when the company beat analysts’ consensus, IBM share price dropped by 5.5% (at the time of writing), highlighting the market’s disappointment with the lack of a significant guidance that could suggest a turnaround in sight. This is the first reason for the correction in stock price.

As mentioned above, IBM reported an impressive $0.27 beat in EPS when the company reported $2.35 vs. an estimated figure of $2.08. However, this impressive beat was achieved due to a massive one-time tax benefit of $1.2B for previously paid non-US taxes that drove the company’s effective tax rate down to negative; otherwise, the company would have missed the Q1 EPS consensus. This is the second reason for the sell-off.

A previous article about IBM that was published before of the results announcement put IBM’s strategic imperatives in focus ahead of the earnings release, highlighting that the company’s transition into a massive cloud company will take time, and IBM should continue to present a moderate increase in the portion of revenues that the company’s strategic imperatives generates. IBM reported a 34% increase in revenue generated by its strategic imperatives (analytics, cloud, mobile, security and social), which was higher than in the previous earnings release; however, trying to extract accurate information about the strategic imperatives progress is almost impossible and could be very frustrating. When IBM announces that the company continues with strong growth in strategic imperatives and provides only vague information about the category and the subcategories’ performance, it is hard to assess how that business is growing and how the transformation is progressing.

As the company’s transition into a cloud services company is still underway, IBM continues to pay for workforce transformation and real-estate actions that totaled $1.5B in the first quarter. These massive transformation expenses hit pre-tax profits sharply and pre-tax margins decreased from 15.3% in Q1 2015 to 5.5% in Q1 2016. Ideally, these transformation expenses should be one-time hits that will improve the company’s operating profit in the future. However, the lack of transparency, in the expected length and magnitude of the shift that the company is undergoing, makes it hard to believe that it will not continue on to the next quarter, as well. From an investment point of view, this is a very problematic situation that does not help the stock price.

In the earnings call, IBM’s executives described the company’s efforts to expand the business and to shift it towards a cloud-based service by mentioning the partnerships and acquisitions that IBM had made in the first quarter. Even though IBM presented some of its plans to implement the acquired companies, it is still unclear whether or not the implementation process will be successful and add value to the company. As the number of acquisitions rises rapidly (the company already announced another acquisition, that of Aperto), the risk of failing to implement all these acquisitions increases, with the negative example of 3D Systems (DDD) coming to mind. IBM doesn't want to be in that place. However, it is still too early to call.

Even though IBM beat the analysts’ consensus in its latest earnings call, the company still has many problems that should alert investors before they leap in. I stick to my thesis, which I had published after the previous earnings release, that IBM is moving in the right direction, but an inflection point is still far away. For now, I see a further decline of IBM before a rally in the stock price, so investors should remain patient, keep Big Blue on their watchlist, and wait for signs of a turnaround, which still haven't come.

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