Technology elder statesbusiness IBM (NYSE:IBM) beat expectations on revenue and earnings when it reported its fourth-quarter numbers this week, and it offered relatively upbeat guidance. But despite that good news -- which the market applauded with a share-price pop -- there are still plenty of reasons to be pessimistic about the company.
As MarketFoolery host Chris Hill and senior analyst Aaron Bush discuss in this segment of the podcast, revenue was actually flat -- which is progress for Big Blue -- and while its "strategic imperative" segments are growing, overall results are still weighted down by the shrinkage in its legacy businesses. The two Fools also talk about IBM's ability to compete with Amazon and Microsoft in the cloud, the potential of its Red Hat acquisition, and whether this stock is one you want to add to your portfolio now.
A full transcript follows the video.
This video was recorded on Jan. 23, 2019.
Chris Hill: Let's start with big blue. IBM's fourth-quarter profit and revenue came in higher than expected. The guidance for 2019, I think, is what is driving the stock. Shares of IBM up 8%.
Aaron Bush: I mean, I wouldn't get too optimistic just looking at the guidance. The company itself continues to trudge along. Like we say pretty much every quarter, IBM's best days are way, way behind it. This particular quarter was pretty much just more of the same. Revenue fell a small amount, but revenue growth for the full year is essentially flat. In any normal context, you'd say, "That sucks."
But looking at IBM and given what they've been through over the last several years, just bleeding revenue, that's progress. It's better than it used to be mainly because some of their growing businesses -- like AI, analytics, application management -- are now a larger percentage of revenue than they used to be. The growth from those businesses is driving larger changes in the business. But it's still not that good, as other core parts of the business are still in decline. Although IBM has relationships with many major enterprises out there, there's no way, on its own, that it can compete against companies like AWS, Azure when it comes to the cloud. The core of IBM, in my mind, is still entirely uninspiring.
Hill: Let me push back in this regard. The obituary for IBM has been written a couple of times in the last 20 years. You can go back to the late 80s, early 90s, where people were saying, from an investing standpoint, things not too different from what you're saying right now. Essentially, best days are behind it. And you can look at a chart of IBM, there were stretches of time where this was a market-beating stock. Mid-90s to the early 2000s, late 2008 for the next five years. It was kind of surprising, the way that they were performing. My question is, even though they've got all this competition -- particularly, as you mentioned, against the likes of AWS and Azure -- would it surprise you if, the next five years, this was a market-beating stock?
Bush: It would surprise me if it were a market-beating stock. The core of IBM is still in a tough spot. I think the businesses that are doing well are going to be a larger percentage of revenue. But when you have these other massive businesses that are a part of IBM still in decline, coming to beat the market and beating other companies that don't have any of that baggage, that's tough.
When you look at IBM's earnings, though, it's smart not to write an obituary mainly because we can't forget that their upcoming acquisition of Red Hat is still in the works and will close later this year. IBM is about a $120 billion business now. They're spending $34 billion to acquire Red Hat. That's the largest software acquisition ever. That should accelerate their efforts to become more modern in the cloud market. I think that that deal is interesting. Red Hat's products are pretty much entirely open source, I think, and the business model there builds around support and professional services, which IBM has lots of experience in. It should help them accelerate their expertise in hybrid IT, helping companies work across multiple public clouds, private clouds, legacy infrastructure. Red Hat has other more technical products like Kubernetes, which helps what's known as containerized applications, which means developers don't have to run a virtual machine for every single application that they're working with. That's super technical, but that's a big, growing field that should help modernize IBM's business.
That said, it's massive. It's the most obvious Hail Mary that I've seen in tech, I think. And it makes sense why IBM would do it. They need something like this. But I don't know how smooth it will go. I bet some of Red Hat's people will jump ship. There's going to be culture clash. And even though IBM will probably want to do lots of cross-sells, I don't know if all of Red Hat's customers will want to buy lots of other IBM services. I think it'll be fascinating how it goes down.
Definitely not writing an obituary, here, but I think that we still can find better stocks than IBM.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Aaron Bush owns shares of Amazon. Chris Hill owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon. The Motley Fool owns shares of Microsoft. The Motley Fool has a disclosure policy.