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IBM's Declining Revenue Gives Mr. Market Big Blues

By Motley Fool Staff – Updated Apr 25, 2017 at 2:05PM

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Despite an earnings beat, IBM shares slumped in light of its 20th straight quarter of lower total revenue.

In this segment from Market Foolery, host Mac Greer, Million Dollar Portfolio's Matt Argersinger, and Supernova and Rule Breakers' Aaron Bush reflect on the situation of tech pioneer IBM (IBM -0.55%), which they note is pushing into so many hot new technologies it's become hard to describe just what the company does anymore. But what it does in most of those areas, lately, is lose ground, a fact that justifiably has investors a bit more pessimistic about its transformation. 

A full transcript follows the video.

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This video was recorded on April 19, 2017.

Mac Greer: Shares of IBM down sharply on Wednesday. Matt, on Tuesday, IBM, reporting better-than-expected earnings, but a decline in quarterly revenue. That's the 20th straight quarter of declining revenue. That doesn't sound very good.

Matt Argersinger: It doesn't sound good. But forget the results, forget the 20th consecutive quarter, forget the 50% drop in free cash flow, forget the fact that the company is constantly in a state of business and capital restructuring. Forget all that. Here's a question. What the hell does this company do? Can I say that on air?

Greer: Cloud computing?

Argersinger: Logistics services, business solutions? According to the 10-K, IBM is a "cognitive-solutions and cloud-platform company with a focus on industry capabilities and expertise." That's the abridged version. The business description goes on for several pages in the annual report. We see all those clever commercials with Watson. How does that really work? Can I buy a Watson? Can The Motley Fool by a Watson to help us pick better stocks? I could use it.

But I'm confused as to what IBM is today, and what it's doing. And I'm also very confused as to why Warren Buffett has invested in this company. I know the fact that everyone talks about that Warren Buffett lost money investing in IBM. But that's not really what I'm getting at. For years and decades, Buffett came out and said, "I don't want to invest in companies that are going to be doing something drastically different in the future than they were doing in the past." And most of the time he called out high-technology companies as an area outside of his circle of competence. I can't think of a company that's more outside of Warren Buffett's circle of competence and is constantly changing than IBM.

So why is Warren Buffett investing in this company? And why is he not investing in a company like [], which is simply Earth's most customer-centric company. Jeff Bezos is a CEO-founder that Buffett admires. Yet Buffett is investing in IBM. There's so many questions I have about this company. I don't really care about the results. I just don't understand what this company does, and why someone would invest in it.

Aaron Bush: And I don't care about Warren Buffett, but this is what I would say. If IBM were a ship, it's like there's a giant hole at the bottom, and management is so focused on saying, "Let's navigate this way," and completely ignoring the hole at the bottom. If you look at their five different business units, four of them are going down, and only one of them is going up, and it's only up 2% this quarter.

Greer: And what unit is that?

Bush: That's the cognitive-solutions business unit.

Greer: So that's the bright spot.

Argersinger: And it's only up 2%.

Bush: And it's only up 2%. You don't even need your sunglasses. It's not that bright. I would just say, every quarter that goes by, cloud and Watson does play a bigger role. And I feel like this same commentary about IBM has been going on for as long as I've been paying attention to the stock at all. 

Argersinger: And that was since you were about 10 years old, so, not too long ago. [laughs] 

Bush: [laughs] But it has improved. I think it's moving in the right direction. But yeah, management is playing by the same rules that they always have been, slowly moving in the right direction, slowly reinvesting into bigger opportunities. But still, the majority of their cash is going to dividends, it's going to share repurchases. If they were really serious about kicking things in the right direction, I think they would divest more, they would more heavily reinvest in their own Watson-like AI applications, and they would probably pursue acquisitions more heavily. But they're just doing the same thing, trying to move in some direction while ignoring the hole at the bottom of the ship.

Greer: Let's talk about one of the bright spots, which was their cloud-computing revenue. The quarterly cloud-computing revenue up 33% year over year. Is that where the future is for IBM? Is it all about the cloud? Or is that not going to be enough?

Bush: I think there's definitely a piece. I think it has to be a piece of it. And I think IBM views their role maybe a little bit different from how Microsoft Azure or Amazon Web Services would be in here. I think Amazon, Microsoft, Google, those guys are more focused on probably what IBM would view as the commoditized portion of the cloud, where it's just a bunch of services that you can rent or use more on the spot, depending on your demand. But IBM, I think, views their role more, I don't know if I would say people-centric, but more like the integrateds. Like, they're going to help you figure out how to put things in place. They're going to leverage their existing customers who have been super-legacy for a long time. They try slowly moving them into something higher-tech. But, I mean, there definitely is a place for these guys. And they have the customers to take advantage of. But they're not being a game-changer here.

Greer: OK. Shares of IBM down more than 20% over the last five years, that's versus the S&P, which was up more than 65%. So guys, when you look out over the next five years, does IBM beat the market?

Bush: No.

Argersinger: I would say no. Any kind of earnings gains, or dividend increases, it's all coming from financial engineering, I think. Even this cloud business that maybe is the lone bright spot, it's essentially just replaced what used to be their mainframe business for decades. So a lot of it is just moving parts around, not really having a focused strategy. As Aaron has talked about, it's a rudderless ship.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Aaron Bush owns shares of Amazon. Mac Greer owns shares of Alphabet (C shares). Matthew Argersinger owns shares of Amazon. Matthew Argersinger has the following options: short December 2017 $800 puts on Amazon. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Amazon. The Motley Fool has a disclosure policy.

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