After having come back from a crisis in the 1990s, IBM is once again in the midst of a massive — and massively difficult — transformation. The company, under CEO Ginni Rometty, is rumored to be planning the biggest shakeup in its history as it tries to find a path toward new growth. But the challenges facing IBM and Rometty have been clear for some time.
The first signs of trouble emerged more than a decade ago for IBM. In 2004, JPMorgan Chase (NYSE:JPM) CEO Jamie Dimon stunned the technology world when he abruptly canceled the Wall Street bank’s $5 billion contract for IBM to run its computer networks. Dimon had decided that his bank could do the work cheaper itself.
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At the time, outsourcing was all the rage and Armonk, New York-based IBM was one if its leading cheerleaders. The company acquired PricewaterhouseCoopers’ consulting group for $3.5 billion in 2002 with the intent of building up its Services business — selling “solutions” rather than just hardware or software. For a while the strategy worked. Even as margins in IBM’s hardware and software businesses came under pressure, IBM’s services revenue surged from $46.2 billion in 2004 to $60.1 billion in 2011, an increase of 30 percent.
Lately, though, growth in the business has evaporated. Revenue fell in 2011, 2012 and 2013, and the decline continued in 2014: What IBM calls “Global Technology Services,” which includes IT outsourcing, saw revenue drop 3.7 percent to $37.1 billion. IBM’s “Global Business Services,” which focuses on higher-end management consultants, saw a similar drop. Revenue in that operation dropped 3 percent to $17.1 billion.
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Rometty has moved the company further away from chips and hardware, selling off businesses that generated sales but not profits. She pushed IBM further into areas such as data analytics and cloud computing. The growth in cloud computing, in particular, had caught IBM off guard. “They weren’t blind to it,” Morningstar analyst Peter Wahlstrom said in an interview, but “they didn’t have the right suite of products.” In October, Rometty told investors that the company needed to adapt faster to changing market conditions.
Those high-profile businesses have been making double-digit revenue gains, with cloud computing revenues growing by 50 percent year-over-year in each quarter of 2014. (For all of 2013, IBM reported $4.4 billion in cloud revenue.) Still, that’s still a drop in the bucket for a company expected to report 2014 sales topping $100 billion and the growth there hasn’t been enough to offset the declines in IBM’s traditional businesses, like services.
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“Our strategic direction is clear and compelling, and we have made a lot of progress,” said IBM Chief Financial Officer Martin Shroeter in an earnings conference call with analysts last Tuesday. “We have been successful in shifting to the higher value areas of enterprise IT. The strong revenue growth in our strategic imperatives confirms that, as does the overall profitability of our business.”
Many on Wall Street are considerably less optimistic about Big Blue’s prospects, or the timetable for its turnaround, and the quarterly results the company announced last week didn’t help convince those skeptics. Though its profit excluding one-time items was $5.81 per share, exceeding Wall Street expectations, IBM reported its 11th straight quarter of flat or declining growth. Its revenue was a disappointing $24.1 billion. The company’s guidance for the months ahead also lagged Wall Street’s expectations.
Disappointing Wall Street has become the trend for IBM. The stock was the worst performer among the 30 in the Dow Jones industrial average last year, marking the second year in a row IBM had that dubious distinction.
The weakness has ratcheted up pressure on Rometty, who angered investors in October when she abandoned a 2015 profit forecast that had been issued in 2012 by per predecessor, Sam Palmisano.
Supporters argue that Rometty is making the right moves by focusing on areas with the greatest long-term potential, even if it means angering investors more focused on near-term results. And Rometty is expected to push ahead with more changes in the coming weeks, including during IBM’s Feb. 26 investor meeting.
“Now that IBM has put the financial roadmap out to pasture and pressure on management is high, we expect CEO Ginni Rometty to be aggressive in the transformation of IBM,” Steve Milunovich, an analyst with UBS, wrote in a note released before the earnings report last week. Milunovich has a “neutral” rating on IBM. “We hear rumblings of management changes coming, perhaps in the second level of executives if not those most visible to investors.”
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The changes may not be enough, or they may not take hold quickly enough, to satisfy Wall Street. Meanwhile, rivals such as Hewlett-Packard (NYSE:HPQ) and eBay (NASDAQ:EBAY) have earned kudos from investors for their plans to split themselves into multiple companies. Some money managers, such as Timothy Ghriskey, who helps manage $1.5 billion for Solaris Asset Management, think that IBM should consider following their lead. Ghriskey says Rometty has an opportunity to do “something radical” by splitting up the company. Ghriskey notes that the “jury is still out” on whether that strategy is the right call.
Though Morningstar analyst Wahlstrom likened IBM to a “battleship,” he doesn’t support splitting the company up, saying the company’s three main businesses complement one another. That’s a view echoed by IBM spokesperson Ian Colley, who noted in an email that the company was “constantly evolving to stay at the innovative edge of the industry.”
IBM, though, needs to convince Wall Street, its customers and employees that it can back up its noble-sounding words with more action. The next steps will likely come very soon.
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