2014 Will Be a Big Year For IBM

After losing server market share to Hewlett-Packard in 2013, along with seeing Amazon dominate the cloud computing market, 2014 will be a far better year for IBM. The launch of ambitious cloud software and services should keep IBM on track to meeting it's long-term goals, and continued share buybacks should give a nice boost to the EPS.

Jan 2, 2014 at 6:00PM

2013 has not been kind to IT giant IBM (NYSE:IBM). The company's stock has been declining since hitting highs last March, with disappointing earnings and a collapse of the hardware business in emerging markets largely to blame. IBM was the only stock in the Dow Jones Industrial Average to decline in 2013, even after a significant end-of-year surge.

2014 will be a year of challenges for IBM, but the company should continue to make progress toward its long-term goals. Hewlett-Packard (NYSE:HPQ) managed to win some market share from IBM in the server business in 2013, and the general trend toward cloud computing will continue to pressure IBM's hardware business and the server industry as a whole. Meanwhile, Amazon's (NASDAQ:AMZN) aggressive expansion of its cloud services has put IBM in the position of playing catch up, with at least one high-profile private cloud contract going to the retail giant instead of Big Blue in 2013. There's certainly plenty to worry about going forward for IBM, but many of these worries seem overdone.

The shifting server market
IBM's strategy over the past decade has been to continually shift out of low-margin businesses into high-margin businesses. By 2015, IBM expects to generate at least 50% of its profit from software, a business that carries extremely high margins. The recent weakness in IBM's server business, then, doesn't matter very much in the grand scheme of things. Unlike competitor HP, IBM derives most of its profits from software and services.

So the recent turmoil in the server market, with falling sales resulting from big web companies like Google resorting to building their own servers, affects IBM far less than competitors. IBM is more an IT company than a hardware company, and this shift will continue in 2014.

Cloudy, with a chance of profit
Amazon has quickly become the leader in cloud services, offering elastic cloud computing and storage through its web services business. It's aggressive cost cutting has led to astounding growth, and the company is the clear leader in the cloud computing market.

But what Amazon sells is a commodity, and competitors like Microsoft have been matching Amazon's price cuts dollar for dollar. IBM has no interest in selling low-margin commodities, so the company is taking a different route. Instead of competing against Amazon and Microsoft by selling commodity cloud computing and storage, the company is focusing instead on delivering software via the cloud. IBM's recent acquisition of SoftLayer, along with a dozen other cloud-related acquisitions over the past 5 years, has allowed the company to quickly build up it's cloud computing business.

Last month, the CEO of SoftLayer told the NY Times that IBM will be launching more than 100 products, like e-commerce and marketing tools, delivered via the cloud in 2014, along with 40 infrastructure services like big data analysis. He says that "it will take Amazon 10 years to build all of this," giving IBM a big advantage if its offerings prove successful. IBM has a lot of resources to throw behind the effort, and 2014 looks like it will be a big year for IBM's cloud business.

One of IBM's ambitious long-term goals is to reach $20 of per share adjusted earnings by 2015. While the hardware problems of last year caused some to doubt IBM's ability to reach this goal, continued growth in software and services, coupled with massive buybacks to reduce the share count, gives IBM a good chance of hitting its target.

The bottom line
While 2013 was a tough year for Big Blue, with its hardware business faltering and Amazon charging ahead in the cloud, 2014 should prove to be quite a bit better. IBM's focus on high-margin cloud software and services, as opposed to commodity computing and storage, should allow the company to achieve it's trademark high-margins as it grows out it's cloud computing business. IBM is still on track to reach its 2015 goals, even with the setbacks of 2013, and those writing off IBM as a tech dinosaur will likely be proven wrong this year.

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