IBM (IBM 3.44%) shares recently dropped to a 52-week low after the company posted a mixed second quarter earnings report. Its revenue fell 5% annually to $19.29 billion, which missed estimates by $160 million. Its non-GAAP operating earnings rose less than 1% to $2.97 per share, but still beat expectations by $0.23.
The reason for Big Blue's revenue decline was a familiar one -- its higher-growth strategic imperatives (cloud, mobile, analytics, social, and security) couldn't grow fast enough to offset the ongoing declines at its older enterprise software and hardware businesses. But looking ahead, it's hard to see IBM's prospects improving anytime soon for four simple reasons.
Source: Getty Images.
1. 21 quarters and counting...
IBM's quarterly revenue has fallen year-over-year for 21 straight quarters. Analysts expect its revenue to fall 2.6% this year and dip 0.3% next year. At this point, all investors want IBM to do is to post a single quarter of sales growth -- but that seems unlikely considering how poorly its core businesses fared last quarter:
|
Business segment |
Q2 Revenue |
YOY growth |
|
Cognitive Solutions |
$4.6 billion |
(2.5%) |
|
Global business services |
$4.1 billion |
(3.7%) |
|
Technology Services & Cloud Platforms |
$8.4 billion |
(5.1%) |
|
Systems |
$1.7 billion |
(10.4%) |
|
Global Financing |
$415 million |
(2.2%) |
Source: IBM Q2 earnings.
IBM's strategic imperatives are scattered across those businesses, but their growth certainly didn't move the needle in any department. Foreign currency impacts exacerbated that pain, but all five units still posted negative growth on a constant currency basis.
2. Slowing growth in its strategic imperatives
The bull thesis for IBM depends on its strategic imperatives growing fast enough to offset the declines at its legacy businesses. However, IBM's SI revenues rose just 11% annually during the quarter and accounted for 43% of its trailing 12-month revenue. That growth is disappointing compared to its previous quarters:
|
Q2 2016 |
Q3 2016 |
Q4 2016 |
Q1 2017 |
Q2 2017 | |
|
SI annual growth |
12% |
16% |
13% |
12% |
11% |
|
% of IBM's trailing 12-month revenue |
38% |
40% |
41% |
42% |
43% |
Source: IBM quarterly reports.
If this deceleration continues, we could see IBM's SI revenue growth drop to the single digits before its weight on the top line crosses the 50% mark.
3. Being crushed by Amazon and Microsoft
IBM claims that its cloud businesses has an annual run rate of $15.1 billion. At first glance, that figure looks comparable to Amazon's (AMZN 1.66%) annual run rate of about $15 billion for AWS (Amazon Web Services), or Microsoft's (MSFT 1.92%) annual run rate of $18.9 billion for its commercial cloud business.
But a large portion of IBM's cloud revenue comes from its slower-growth private and hybrid clouds. The higher-growth "cloud as a service" segment, which competes against Microsoft and Amazon, had an annual run rate of just $8.8 billion. That's disappointing when we consider that most of Microsoft's commercial cloud revenues come from cloud services like Office 365, Dynamics, and its infrastructure platform Azure.
Source: Getty.
Meanwhile, Amazon's AWS is the largest cloud infrastructure platform in the world. IBM's comparable platform, Bluemix, only generates a small (and undisclosed) percentage of the $8.4 billion in technology and cloud platform revenues that it reported last quarter.
Simply put, IBM remains far behind Amazon and Microsoft in the faster growing parts of the cloud market. That's disappointing considering how frequently IBM highlights its next-gen cloud services -- which include its AI platform Watson, quantum computing platform, and blockchain-powered security solutions.
4. A lack of insider and investor confidence
If IBM were on the brink of reporting top line growth again, we should see a lot of insider buys. After all, the stock trades at just 12 times earnings (compared to the industry average of 19 for IT services companies), pays a solid forward dividend of 4.1%, and is trading at a 52-week low.
Yet IBM insiders have sold over 140,000 shares on the open market over the past 12 months, compared to purchases of just under 62,000 shares. And it's not just the insiders who are selling -- Warren Buffett, who held IBM as one of Berkshire Hathaway's top holdings, sold about 30% of his position when the stock hit $180 in February.
The key takeaways
Back in May, I told investors that it would be a mistake to sell IBM. The stock has slipped about 3% since that article was published, but I still believe that its downside potential is limited by its low valuation and high yield.
However, IBM's upside potential is also limited by its lack of sales growth and its inability to counter Amazon and Microsoft in the cloud services market. Those problems will weigh on Big Blue for many quarters to come, and the stock will likely underperform the broader market.
