IBM announced October 17 that its revenues have fallen for 22 quarters in a row. Its current CEO has been able to survive, I think, by dangling a shiny object in front of investors — just wait long enough and a bucket of new businesses will pick up the slack from the old, declining ones.
Of course that shiny object has continued to be out of reach for five years. And now a new story is emerging — the oldest of IBM businesses, mainframe computers, is the thing that will restore IBM’s growth.
Is now the time to buy IBM stock? I have no financial interest in its shares and see no reason to change that now.
But first, let’s look at its third quarter results. Third quarter was down about 1% — but — at $19.15 billion — about $500 million more than expected. And IBM’s adjusted operating profit of $3.30 a share was two cents higher than analysts expected, according to Bloomberg.
Behind IBM’s persistent decline is that shiny object — which IBM dubs inelegantly as “strategic imperatives” which include analytics, security and Watson-branded products. And these strategic imperatives sucking up cash without boosting revenues enough to make a difference. To be fair, strategic imperatives — enjoyed an 11% increase in revenue to $8.8 billion in the quarter — account for 46% of IBM revenues but the other 54% — the old businesses — have been falling faster than the new ones have grown. And its cloud unit enjoyed a 20% increase in revenue to $4.1 billion.
But in the third quarter, IBM’s significant growth came from its old businesses — hardware and software.
IBM’s systems unit — helped by improved sales in data storage products and the new mainframe server, which became available late in the third quarter — reported a gain. And its cognitive solutions — which hosts Watson analytics and other newer products for IBM — grew 3.9% after falling in the previous period according to Bloomberg.
IBM CFO Martin Schroeter told Bloomberg, “Cognitive solutions has attracted a lot of our investment, and when we look at underlying performance, it captures and reflects a lot of the new strategic imperative areas we’re going into [and are a key indicator for IBM’s future success]. We saw pretty broad-based growth across all cognitive solutions elements.”
But analysts see hope for growth coming from IBM’s legacy mainframe business. Josh Olson, an analyst at Edward Jones told Bloomberg, “The mainframe is going to drive a lot of the positive growth in the fourth quarter. When you’re selling mainframes, you’re also selling a lot of software and services with that.” Olson sees the mainframe business as cyclical and expects that IBM will not be able to sustain growth server sales begin declining. He thinks that cloud software and services are the best candidates for helping IBM to resume revenue growth.
IBM’s stock — which had fallen 11% during 2017 before the announcement — may have risen (it’s up 6.7% in October 18 pre-market) possibly due to a brighter forecast for the final quarter of 2017. Fourth-quarter revenue is projected to be between $22 billion and $22.1 billion — which would be a tiny 1.5% increase from the year before — and that is higher than the $21.8 billion analysts had forecast before the announcement.
The fundamental reason to avoid IBM stock is that it lags its rivals when it comes to innovation. I’ve written about six industries in which IBM is losing to more focused competitors. IBM leaves its flanks exposed because it feels compelled to force its customers to buy products that do not meet their needs very well and cost much more — so customers who can buy better solutions at lower prices are eagerly doing so.
IBM will only be able to grow if it can create new product categories that better meet the needs of its customers than do rival products. To be fair to IBM, its Watson business appears to be an effort to do just that. However, since it does not report the revenues from this line of business, it leaves analysts in a quandary. Will Watson ever be significant enough to boost IBM’s top line or is it a smokescreen to divert investors from IBM’s true financial prospects? And if not, can IBM invent a new product line that will put it ahead of its speedier and more focused rivals?
After five years, IBM CEO Virginia Rometty has likely exhausted the patience of IBM’s board and its investors — if IBM does not prove it can grow sustainably in the next quarter, perhaps IBM’s ridiculously patient board will decide it’s time for a change.