IBM Emerging as Cognitive, Cloud Power Amid Transformation

Despite a run of quarterly losses, IBM shows "proof points" that cognitive and cloud are driving its transformation to higher value.

IBM initiatives

Still in the midst of a massive turnaround, IBM this week announced first quarter earnings that were less than stellar as the technology giant valiantly fights to transform its focus from commodity systems and software to higher value opportunities like the cloud, mobile, analytics and cognitive systems.

The good thing about IBM's move is that the majority of its client base also is in the process of digital transformation and is looking to companies like Big Blue for help. However, with the first quarter of 2016 being the company's 16th consecutive quarter of revenue decline, the question begs asking: Is the transformation taking too long?

To better focus the company on its transformation journey, IBM has adopted a new reporting structure to reflect its emergence as a cognitive solutions and cloud platform company. IBM's new business segments consist of Cognitive Solutions, Global Business Services, Technology Services and Cloud Platforms, Systems, and Global Financing.

IBM Cognitive Solutions includes solutions software and transaction processing software. IBM Global Business Services includes consulting, global process services and application management. The IBM Technology Services and Cloud Platforms segment includes infrastructure services, technical support services and integration software. The IBM Systems segment includes systems hardware and operating systems software. And the IBM Global Financing segment includes financing and used equipment sales.

During IBM's earnings call this week, Martin Schroeter, the company's CFO, said IBM's enterprise clients are looking to get greater value from their data and their IT environments—not just focused on reducing costs and driving efficiency, but using data to improve decision-making and outcomes.

"They are looking to become digital enterprises that are differentiated by cognitive," he said. "Our strategy is based on the point of view that this requires a solutions focus, industry expertise, and innovative technology, all supported by leading-edge skills."

That is why IBM is "creating cognitive solutions that marry digital business with digital intelligence," Schroeter said. "We're bringing our industry expertise together with these cognitive solutions, and we're building it all on cloud platforms."

And because IBM is running many of its clients' most critical business processes today, the company is in a unique position to move them to the future, he added.

IBM is focusing on what it calls its "strategic imperatives" to continue to drive its transformation. These imperatives include analytics, cloud, mobile, security and social. In the first quarter, these imperatives pulled in $7 billion for IBM and grew 17 percent year over year. Over the last 12 months, the strategic imperatives accounted for $30 billion in revenue, amounting to 37 percent of IBM overall revenue for that time period, Schroeter said.

"The problem for IBM is it is being measured as a declining legacy hardware/software vendor and not yet as an emerging cloud AI [artificial intelligence] vendor even though that segment had a whopping $30 billion at a 17 percent growth rate in a mixed, crowded (cloud) emerging (Watson) segment," said Rob Enderle, founder of the Enderle Group.

Yet, he added that even at $30 billion, that figure is still less than half of IBM's total revenue and the decline of the legacy component, which is overwhelming the growth of the new business.

"If they separated the legacy more profoundly from the part of the company doing cloud and AI, that part would be worth substantially more than the combined entity because folks would more readily see the upside," Enderle said.

This showcases that while IBM significantly beat Wall Street estimates, their shares still dropped after hours, he noted.

"With all of this they actually generated a rather impressive amount of free cash as well as decent dividends making the shares a good buy for those that would like a long term investment with some kind of interim cash flow—in other words, folks in my age group," Enderle said. "I expect that IBM is due for a pretty large positive valuation adjustment once the legacy business drops below 50 percent and the new business can better represent what the company is becoming."