IBM's (NYSE: IBM ) management used its recent investor day to affirm its commitment to its target of $20 in earnings per share by 2015. Usually, this sort of news meets with a favorable response from the market, but the sell-off in the stock indicates that investors have some concerns. Not only does IBM have a lot to do to hit the target, but it's relying on its growth initiatives in areas where it faces increasing competition from rivals such as Oracle (NYSE: ORCL ) and Microsoft (NASDAQ: MSFT ) . So what do you need to know about IBM's strategy to return to growth?
IBM's skeptics multiply
Investment analysts tend to produce estimates that come pretty close to management's guidance or slightly above it. This fact makes the consensus forecast for IBM's 2015 earnings of $19.81 all the more interesting. As a group, they don't believe IBM will hit the number, and the following points mark why they might be skeptical. I'll start with a breakout of how IBM's segment revenues have grown in recent years.
- As the chart above demonstrates, IBM is experiencing significant difficulties in growing revenue as even its service growth has turned negative.
- As discussed in an article linked here, IBM's recent affirmation of its full-year EPS guidance for 2014 is de-facto a downgrade of its pre-tax profit expectations, because it lowered its estimate for its full-year tax rate.
- Hardware revenue (in the systems & technology segment) has fallen off a cliff and is suffering from its exposure to weakening emerging markets.
- IBM is relying on growth from its planned $1.2 billion investment in offering infrastructure as a service, or IaaS, but the market is becoming crowded with Oracle, Microsoft, and others investing aggressively in it.
- IBM's planned $1 billion investment in its Watson supercomputer system in order to offer cloud-based Big Data analytics is exciting, but it contains the usual risks associated with business execution.
The first article linked above fleshes out many of the themes associated with the first three bullet points, but the last two are worth looking at in more detail. They both involve IBM investing in growth platforms; the company will need this in order to hit its EPS target in 2015.
IBM's investment in growth platforms
Amidst the doom and gloom of IBM's declining growth, its business analytics revenues have consistently beaten its expectations. For example, it had targeted $16 billion in big data analytics business by 2015, but upgraded this target to $20 billion in January after it surpassed the original target provided with last year's figures. Indeed, the success of its big data growth is surely behind the decision to invest in Watson.
Analysts think there is a lot more to come from IBM in business analytics. For example, J.P. Morgan analyst Mark Moskowitz estimates in a recent research report that IBM's business analytics revenue could hit $25 billion by 2017 and Watson could contribute $2 billion to this annually by 2017. These figures are significant in comparison with IBM's revenue of nearly $100 billion in 2013.
Similarly, the investment in expanding its IaaS services helps the company sell applications and solutions (such as Watson) to customers. Unfortunately, IBM is not alone in undertaking this kind of strategy. Oracle is investing heavily in order to try to convince customers to run new and existing Oracle applications on the Oracle IaaS. Microsoft is taking a similar approach with its IaaS offering, Azure, and there is little doubt that Oracle and Microsoft (among many others) are trying to shift away from the old model of on-premise on-license software toward cloud-based solutions. The IaaS market is not short of competition.
The bottom line
All told, IBM's growth platforms are exciting, but they don't come without the usual caveats associated with growth initiatives in highly competitive markets. Meanwhile, it continues to struggle with its traditional businesses.
In addition, the investment community continues to express a certain amount of skepticism over its $20 EPS target for 2015. It almost seems that the best thing that IBM could do to bolster enthusiasm for its stock would be to shelve the plan. Such an event would likely be a short-term negative for the stock, but it could create a great entry point.
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