IBM beats on Q4 FY2015, can't catch a break with analysts
- Summary:
- IBM turns up a better than expected Q4 FY2015 but still can't keep investors happy. The internal business transformation continues but is relying more on acquisitions than improving its own processes.
A continued mixed bag
In fairness, IBM has significant currency headwinds that impacted EPS by eight points and are forecast to have a full $1 impact on the anticipated EPS result for 2016, now pegged at $13.50. Even the relatively strong Z-systems and cheery Power outlook did nothing to keep analysts happy. Instead, all eyes are on the software, BPO and delivery businesses.In common with other BPO providers, IBM is feeling the chill wind of commoditization and downward pressure on its transaction business but on the analyst call I didn't hear a single word about automation as part of a BPO modernization. Instead, we heard plenty of vague talk about high value (and margin) business along with a 'remixing' of the employee bench in the transaction business and rebalancing the workforce in SG&A.
On software, the only thing of any substance was a discussion around the 14 companies IBM acquired during 2015 (at a total cost of $3 billion) and in particular The Weather Company deal which IBM hopes will allow it to build new and lucrative solutions that extend beyond usage of weather data. As a small note, IBM says the partnership with Apple to deliver iOS apps has yielded approximately a billion dollars in deal flow.
Elsewhere, IBM continues to invest in data center capacity alongside building Watson competencies, starting with a facility in Munch as representative of its Watson push into Europe. IBM is also building new business units that it hopes will capitalize on the future need for cognitive applications that tie into social, mobile and analytics, a business segment IBM says grew 20% in the last year.
Three major problems
As I see it and despite IBM's upbeat discussion, there are three major problems that prevent it from earning a better rap.
First, IBM emphasizes a hybrid cloud strategy and tends to downplay Software as a Service. It claims the SaaS business is growing well but it is a very small part of the overall pie. In one sense this is perfectly understandable. Regardless of what software companies will tell you, the world's largest customers, many of which continue to use IBM for data center, will not move central ERP systems away from tried and tested data centers anytime soon. They want a better deal and to that extent, IBM has been more flexible in recent years as it tried to ring fence those very large customers. That leads to the second problem.
Having protected a level of core revenue, IBM has little room for ramping the top line software and services revenue numbers. All legacy software is in decline, partly offset by acquisitions, rather than home grown solutions. ERP implementations are in decline and have been for years.
Finally, BPO is under severe price pressure generally and until very recently, IBM did not really have a business unit focused on higher value digitization programs.
It is not all bad. Annuity style business represents around 70% of IBM's software revenue and, according to Martin Schroeter, CFO:
Our annuity business within the software business continues to grow. Outside of our largest clients where customers don't have as broad access to our portfolio, we do see growth. In the large clients we provide flexibility. Renewal rates remain very high in the mid-90s globally and higher still in the Americas.
Even so, Schroeter was not prepared to commit to a 'rapid snapback of margins.' Earlier, Ginni Rometty, CEO IBM said in a statement:
“We continue to make significant progress in our transformation to higher value. In 2015, our strategic imperatives of cloud, analytics, mobile, social and security grew 26 percent to $29 billion and now represent 35 percent of our total revenue.”
In short, the revenue sales funnel for new lines of business is filling up nicely but the old days of high margins on everything IBM touched are not coming back any time soon, or if they are, then it is in small pockets where the company has yet to establish itself as a trusted provider. In the meantime and with few exceptions that make a significant positive dent, what has been IBM's long term bread and butter businesses are all in secular decline, albeit services backlog stands at $121 billion.
My take
The bright news among this mixed bag is that IBM is still throwing off large amounts of free cash. Next year IBM forecasts this will come in at around $11 billion. A good chunk of that will go towards paying dividends and share buy back. I wonder whether the company feels emboldened enough to make a really big acquisition that could add significantly to its top line. Complexity among customer deployments will not ease any time soon and IBM will continue to provide value based services that solve integration problems in mixed private and public cloud environments. But for me it is IBM's ability to transform the big transaction and services units into world class agile units that holds the key for the long term.