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All Contents © 2017The Kiplinger Washington Editors
By James Brumley
| December 2016
Rosemaryetoufee via Wikipedia
To say International Business Machines Corp. (IBM) has been tough to own the past few years would be a considerable understatement. Even with the 43% gain from February’s lows, IBM stock is still down 21% since its early 2013 peak. Most other stocks are well up for the same timeframe.
Granted, last quarter marked the eighteenth consecutive quarter revenue declined on a year-over-year basis. In that light, the stock’s weakness makes sense.
But nothing lasts forever? After all, the IBM shares are up 16% since mid-June. There has to be a reason, right?
Maybe, but if International Business Machines is going to ever justify its recent lofty gains — or even just stop the bleeding — it’s going to have to do these three things.
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Not to imply that International Business Machines doesn’t invest in research in development (case in point? Watson — more on that below), but considering the company hasn’t been terribly competitive in any of its markets of late, clearly IBM stock hasn’t delivered up enough innovation in years.
Granted, it’s not like CEO Ginni Rometty has opted to outright waste its funding. As Credit Suisse analyst Kulbinder Garcha explained in a recent research report, International Business Machines has spent a sizeable fortune on buybacks of IBM stock in recent years, but that has led to led to “an underinvestment in R&D.”
For perspective, the number of outstanding has fallen from 1.115 billion shares in 2012 to 957 million shares as of the most recently reported quarter. At the same time, the company’s research and development spend was $4.4 billion for the past four quarter, versus 2012’s total R&D expenditures of $6.3 billion.
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Calling a spade a spade, the artificial intelligence platform known as Watson has been impressive ever since it played a game of Jeopardy on TV in 2011, and won big-time. Since then, the technology has been put to use as a tool to develop pharmaceuticals, handle cybersecurity duties and more. It’s regarded by some as the future of the company.
To IBM’s credit, Watson is growing revenue, even if it’s not clear to what extent. What is clear though, is that it’s not yet enough. IBM has invested $15 billion in the development of Watson, yet the “Cognitive Solutions” segment that includes Watson only mustered 5% year-over-year growth last quarter, with sales reaching $4.2 billion. That’s only about 22% of the company’s Q3 revenue, and much of that wasn’t Watson revenue.
Dion Hinchcliffe via Flickr
Finally, while IBM stock is at least something of a cloud play, to what extent it is isn’t clear — the company doesn’t cleanly break down its actual cloud revenue.
International Business Machines isn’t a company with a lot of cloud credibility, and is almost suspiciously obscuring the strength of its cloud business, counting things as “cloud” that aren’t actually cloud revenue.
To that end, UBS analyst Eric Sheridan suspects IBM’s true cloud business was only $1.8 billion in 2015, and Sanford C. Bernstein analyst Toni Sacconaghi suggests the company is driving less than $2 billion in cloud revenue per year. That’s a concerning lack of market share compared to other players in the fast-growing space. There’s a reason, and it has to change.
While there’s clearly more to the International Business Machines story than just these three facets, they really are the primary paths to the company’s rebirth.
To that end, it’s worth noting the technology giant’s worst days may be behind it. Last quarter’s year-over-year revenue lull was off by less than 1%, the smallest dip during the 18-quarter implosion. If IBM is doing things right, the next step is forward progress in the top line. We’ll hear that news in January.
Don’t despair if that report isn’t decidedly positive. Turnarounds are a process, and not always a clean one. Whatever turnaround is in the cards though, it’s going to be led on these fronts.
This article is from James Brumley of InvestorPlace. As of this writing, he did not hold a position in any of the aforementioned securities.
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