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How Building a Smarter Planet Could Send IBM Soaring

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IBM's  (NYSE: IBM  ) has announced to the world in its new commercials that its mission is to "build a smarter planet." As part of the effort, IBM is using an artificial intelligence program called Watson to jump-start its cloud computing business. But is IBM and Watson smart enough to send its stock price soaring?

IBM stock price has been in a little tailspin since the company beat net income estimates but missed its revenue estimates on October 16. IBM's net income was up 6% to $4 billion, or $3.68 a share, from $3.82 billion, or $3.33 a share, in the previous year's period. Revenue fell 4% to $23.72 billion from $24.75 billion in the previous year's period. Below is a six-month chart of IBM's stock price.

IBM Chart

IBM data by YCharts

So is there a plausible scenario to buy IBM? Over the last four quarters alone, IBM has spent over $6.24 billion in research and development. That equates to approximately 13% of the company's revenue over the same period. A large part of IBM's research and development dollars have been spent on the quirky artificial intelligence platform the company calls Watson.

I am sure many of you saw the episodes of Jeopardy in May of 2011, where Watson was pitted against the legendary Jeopardy champion, Ken Jennings. The Jeopardy games were actually pretty close and Watson did have some awkward moments. When Watson was given the clue, "Its largest U.S. airport is named for a World War II hero; its second largest for a World War II battle," Watson's response was "Toronto, Canada" The correct response was actually Chicago. Watson ultimately prevailed and won over $1 million on the popular game show. Click here to watch Watson on Jeopardy.

The commercialization of Watson
On February 2013, IBM announced that the Watson Artificial Intelligence Platform would be used in its first commercial application. The Sloan-Kettering Cancer Center in conjunction with WellPoint would apply Watson to its utilization management decisions in the treatment of lung cancer. IBM Watson's Business Chief, Manoj Saxena recently stated that "90% of nurses in the field who use Watson as part of this program follow Watson's guidance," This was Watson's first commercial application. Watson is now also being integrated in other areas of health care, education, customer service and financial management

Watson and cloud computing
In November 2013, IBM announced that Watson's artificial intelligence platform was being opened up to software developers, companies, and individuals through the cloud. Technologists outside of IBM can now integrate Watson's artificial intelligence and collaboration technology along with cloud computing power to solve complex problems through the Internet. With this new program, companies will be able to implement their intelligent platforms faster and at a lower cost.

Potential revenue
I anticipate that Watson will enable IBM to generate a significant revenue and earnings over the next three years. You can actually see this one coming from a mile away. Watson is now the beneficiary of significant brand recognition from its time on Jeopardy. How many executives throughout the world have heard about the legendary performance of Watson on Jeopardy?

And just in case the executive's memories have faded, IBM is now pumping the airwaves and the Internet with advertising espousing the benefits of Watson. In addition, Watson's artificial intelligence technology can be applied to almost every new vertical market and vertical markets sales and marketing is what IBM does best.

The elephants in the room
Google (NASDAQ: GOOGL  ) and Amazon (NASDAQ: AMZN  ) are the big elephants in the room when it comes to the long-term viability of Watson. Google has been one of the best tech investments over the last 10 years and has already done a lot of artificial intelligence work and Google can probably be integrated with an artificial intelligence platform to solve commercial problems with little trouble. I am not saying that Google can easily destroy Watson's powerful earnings potential, but Google can give them some significant competition in the space without much effort.

The other elephant in the room is Amazon. Amazon has significantly more cloud computing power and cloud customers than any other company competing in the cloud computing space. Amazon's first mover advantage has given the company a significant competitive advantage over its competition.

The bottom line
I believe that IBM is poised to generate significant revenue from commercializing Watson. But will Watson translate into increased stock value over the long-term for IBM? IBM has taken a long-term strategic approach to Watson that has setup Watson to be a cash cow for the company for many years to come.

However, IBM should beware. Google and Amazon are very large elephants lurking in the room. Google has excellent technologies that could be used to challenge Watson. Amazon is the current leader in cloud computing and a natural progression of the company could be to add artificial intelligence functionality on top of its cloud computing platform.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 20, 2013, at 9:37 AM, Arden wrote:

    Every company, whatever the value of its stock, is trying to launch new products to keep on growing. It is especially true with large firms that dominate their market and try to find new products to sustain their growth. Experience has proved that the most disruptive innovations stem from unknown players. IBM Watson competitors may not be Google or Amazon but startup companies such as Yseop. When Google came on the market, nobody believed that the new search engine would defeat AOL or Yahoo.

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