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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.”
IBM Emerging as Cognitive, Cloud Power Amid Transformation
For his part, Schroeter argued that IBM has some key “proof points” that it is making progress on its transition. In addition to citing the success of the combined strategic imperatives, Schroeter called out specific components, noting that in the first quarter, IBM’s total cloud revenue grew 36 percent to $2.6 billion, with the as-a-Service components growing 46 percent. IBM’s annual run rate for the “as-a-Service” revenue is now $5.4 billion. And IBM’s analytics revenue grew 9 percent on a large base—it was an $18 billion business last year. Also mobile and security each posted strong double-digit growth, he said.
Moreover, in the first quarter IBM’s cloud revenue reached $10.8 billion over the trailing 12 months, and the company continues to make strides to globalize its cloud portfolio through new investments, innovations, clients, acquisitions and partnerships.
Over the last few months, IBM stepped up its efforts to accelerate the growth of its cloud footprint globally as it focuses on higher value. For instance, in January IBM formed a Cloud Video Services Unit, and at this week’s NAB Show in Las Vegas that unit announced new innovations and client wins including Comic-Con HQ, AOL, Canadian Broadcasting Corporation and Broadway Video.
In addition, during the quarter, IBM announced a new cloud data center in South Africa in partnership with Gijima and Vodacom, expanding Big Blue’s cloud footprint to over 46 data centers across six continents.
Moreover, IBM has cloud enabled its entire portfolio of software and recently delivered 50 new cloud solutions and services across the Internet of Things (IoT), blockchain, Watson, big data and more. The company also doubled down on developers, bringing the popular Swift programming language to the cloud and joining forces with GitHub to help developers create cloud-based apps for the enterprise.
So analysts see IBM moving in the right direction, but is it enough?
Jennifer Hamel, an analyst with Technology Business Research, sees light at the end of the tunnel.
“IBM’s transition to higher-value strategic imperatives, i.e., cloud, analytics, mobility, social and security (CAMSS) progressed in 1Q16, as the company continues to shed its traditional IT services baggage in favor of industry-focused, consulting-driven cognitive solutions,” she said.
Further, Hamel noted that traditional ERP implementations and IT outsourcing remained albatrosses preventing revenue growth in IBM’s Global Business Services (GBS) and Global Technology Services (GTS) units.
“However, total services revenue performance continued to improve in 1Q16, declining only 2.3 percent year-to-year, the smallest year-to-year decline 2013, signaling growth in strategic imperatives is coming closer to replacing losses in traditional services areas,” she said.
Charles King, principal analyst at Pund-IT, said IBM’s new reporting structure is going to take some getting used to, but he noted that the technologies that populate those segments are so deeply integrated into a growing range of IBM solutions that breaking out their discrete financial performance would be difficult.
“I find it remarkable that IBM has been able grow its new strategic businesses and profits despite generating lower overall revenues,” King said.
This is largely due to shifts in the company’s organization, including some headcount reductions but also by significant realignments of its financial priorities, he said.
“As a result, IBM delivered GAAP [Generally Accepted Accounting Principles] diluted earnings of $2.09 per share on $18.7 billion in total revenues,” noted King. “Compare that to HPE’s recent Q1 2016 financial announcement which showed the newly realigned company delivering $12.7B in total revenues but just $0.15 in GAAP diluted earnings per share.”