- IBM's revenue slide is slowing down, new growth drivers are taking their positions.
- Is cloud the real hero of IBM's future story, or do they have another ace up their sleeves?.
- With the rate of revenue decline down to under 5%, it shows in the stock's price movement this year.
International Business Machines Corporation (NYSE:IBM) has been facing investors’ wrath for a long time. As revenues kept moving south over the last four years IBM’s stock kept dropping until it reached its current price of around $158, a loss of more than 25% from its all-time high of $215 which the company reached in March 2013. But since the start of this year IBM stocks’ fortunes have turned around, posting a return of more than 15%.
If you had looked a bit closely at the way the company has gone about its business since Ginni Rometty took over, you’ll notice that not much has changed. The company has identified a few growth drivers, made it crystal clear that they are moving away from some of the old business lines, changed their financial reporting structure and have nicely mixed up parts of the business that are growing with parts that are slowing. And they’ve also stuck to their philosophy of focusing on high margin product lines.
Source: IBM 2013 Annual Report
The company made it clear as soon as Rometty took over that there will be a lot of emphasis on high margin business lines, which they have not been very successful at, as margins have edged lower during the last three years, while earnings per share followed suit.
Is IBM’s Decline Coming To An End?
Several analysts have written about the company saying that IBM is fighting a lost cause. Looking at the stock’s performance it’s clear that the market wasn’t happy with the direction in which the company was traveling. Though stock price has found some new vigor, the momentum may not sustain if IBM’s revenue decline continues - all eyes will be on how much the rate of decline changes.
In the last four quarters, IBM’s revenue decline has slowed down tremendously from the above-ten-percent range during the first three quarters of last year to a less-than-5% range in the first two quarters of the current fiscal.
But the real question to be answered is whether the declining era of IBM is over. Is the company ready to move into the next year showing some growth? As legacy parts of their business slow down, IBM is banking on a few select growth areas to help them get back on their feet.
As such, the company has identified five segments as its future revenue drivers, which it calls its strategic imperatives. Though there are five segments, in reality, it is their analytics and cloud segments that the company is relying on to drive its future.
Alse read: Can IBM Keep Its Dividend Growing?
During the second quarter, revenue from strategic imperatives totaled $8.3 billion, or 38% of their overall revenue. These segments have been growing for a while but, despite the growth, the company was posting revenue decline - a clear indication that other parts of their business were declining at a much faster rate. The slowdown in the rate of revenue decline is a sign that the gap is closing quickly. The day when growth in new businesses fully compensates for the decline in legacy operations is when their next phase of growth will begin.
Why Cloud is Not the Real Hero of IBM
Although the media believes that cloud is what will propel IBM into the future, I can’t agree with that. My reason is simple: analytics, not cloud, is their strong suit. With Watson’s initiatives in analytics bringing in nearly $5 billion this past quarter it is clearly their biggest bet. But analytics itself is not the only answer to their problem. Without the cloud component, analytics-as-a-service would not have been possible, and it is this combination that will propel IBM into the future.
Over the last two-quarters analytics brought in about $9.1 billion, and my estimates show that IBM should finish out fiscal 2016 with between $19 to $20 billion revenue from analytics. There’s serious competition in the cloud infrastructure space and, even though IBM is the leader in hybrid cloud, they simply don’t have the aggressive marketing genes that Microsoft Corporation (NASDAQ:MSFT) has, for example. But they’re the kings of analytics and analytics served on the cloud. That’s where their real growth potential lies. Cloud will definitely support that growth, but I don’t see them dominating the Infrastructure-as-a-Service segment in the long run.
That said, IBM does have the hybrid advantage that will get them more enterprise IT deals than either Amazon.com (NASDAQ:AMZN) or Microsoft can ever hope for. My hope is that their cloud will grow strong, but my confidence is in their analytics division.