IBM: Are There Reasons to Believe in a Turnaround?

IBM (NYSE: IBM  ) is facing a worrying revenue cliff. As a result, shares of IBM have fallen out of favor with investors and trade at only 10 times expected fiscal 2014 earnings, or just two times expected 2014 sales. In comparison, Oracle (NYSE: ORCL  ) trades at 5 times expected 2014 revenue while Microsoft (NASDAQ: MSFT  ) trades at 4 times expected 2014 revenue. A recent Barron's article touted IBM as a good turnaround bet, while others have painted a gloomy picture of the company's future.

It appears as if many investors have forgotten about IBM simply because they associate it with the rapidly declining server business. However, there is a lot more to IBM than meets the eye.

Dominance in application infrastructure and middleware software
What many people often overlook is that IBM has other thriving businesses, and application infrastructure and middleware software (AIM) is one of these.

IBM is the overwhelming market leader in the high-margins middleware and infrastructure market, with almost double the market share of second-place Oracle. IBM raked in $6.44 billion in fiscal 2013 from AIM sales. Microsoft can only lay claim to a 5% slice of this important market.

Worldwide vendor revenue estimates (in millions) for AIM software, 2013.

Company

 

2013 revenues

 

2013 market share

 

2012 share

 

Change in revenues 2012-13

IBM

 

$6,448

 

30%

 

31.1%

 

1.6%

Oracle

 

$3,298

 

15.3%

 

16.1%

 

0.4%

Microsoft

 

$1,084

 

5%

 

5%

 

6%

Software AG

 

$703

 

3.3%

 

3.2%

 

8.1%

Tibco

 

$545

 

2.5%

 

2.7%

 

-2.3%

Others

 

$9,435

 

43.9%

 

41.8%

 

10.8%

Total

 

$21,512

 

100%

 

100%

 

5.6%

Source: Gartner (May 2014)

Revenue from IBM's key middleware products such as Websphere, Tivoli, information management, and workforce solutions and rational products clocked in at $3.7 billion in 2013, 4% growth compared to 2% for the company's software division. Fabrizio Biscotti, research director at Gartner, says that growth in AIM is being powered by the rising interest in cloud and big data analytics, as well as new offerings such as PaaS, in-memory data grids, low-latency messaging, and complex event processing.

According to Trefis analysts, IBM's AIM and operating systems segments account for 45% of its pre-tax income, and 56% of its stock price. The analysts predict that IBM's middleware revenue will grow at a compound annual growth rate, or CAGR, of 25.3% through 2020 to reach $25 billion.

Big data and analytics
Big Blue has spent over $24 billion to ramp up its big data and analytics to date, mainly through R&D and over 30 acquisitions.This has led to more than 40,000 service engagements for IBM. Rapid growth in this field recently led the company to increase its big data revenue projection for fiscal 2015 to $20 billion. The company originally targeted $16 billion by 2015, but achieved that figure in 2013. That's a sign of how lucrative the sector is.

The IDC says that the big data and analytics market is growing six times faster than the overall IT market, and has projected a CAGR of 27% for the market through 2017, to $32.4 billion.

Rapid growth in the cloud
IBM's cloud is the third-largest and second-fastest growing cloud after that of Microsoft. IBM has spent billions of dollars to acquire cloud companies such as Softlayer, Keneax, Trusteer, Sterling Commerce, and DemandTec.

IBM's SmartCloud Enterprise is an infrastructure as a service (IaaS) platform that competes directly with Amazon's AWS. IBM's cloud sports special features such as bare metal capabilities that have helped it compete effectively with AWS.

IBM has also been using this edge to maintain its current pricing, which is important for margin preservation especially now that cloud companies are cutting prices to the bone. The company is also constantly ramping up its cloud offerings to stay competitive in the brutally competitive cloud market.

IBM recorded an annual run rate of cloud-delivered-as-a-service of $2.3 billion last-quarter. The business grew 69% in fiscal 2013. Even allowing for a more modest 25% growth rate through 2020, IBM's cloud business will reach $16.8 billion in annual revenue in 2020, or 17% of its current overall revenue. At this rate, growth in the cloud business alone will be enough to offset the decline in the company's revenue in two or three years.

Conclusion
IBM has a strong presence in several high growth and high-margin areas such as big data and analytics, cloud, and AIM. The company is in a good position to not only offset declines in other segments, but to record healthy growth as well in a few years' time.


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  • Report this Comment On June 06, 2014, at 12:13 PM, peterwolf wrote:

    Are there reasons to believe in an IBM turnaround?? Not with the old lifer dinosaurs that run the place. Have you noticed that IBM ( the world's biggest IT company) has not been the innovator of any of the most important IT innovations of the last 20+ years?? It's been Google, Amazon, Facebook, Twitter, Apple, etc. that have innovated. And this doesn't even include technologies like Cloud, which you would have thought IBM would have introduced and dominated. No, the problem is the company is hopelessly mired in their own internal rules, regulations, politics and favoritism. And when the top line impacts the bottom line?? They simply layoff more people to keep the EPS where they want it. Yet none of that has propelled the stock price because the market understands that IBM is not where IT innovation and growth is happening.

  • Report this Comment On June 12, 2014, at 11:28 PM, km00nster wrote:

    A good move for IBM is to buyout Splunk. Really fast growing Data Analytics company with a great product.

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