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IBM Loses Its Groove

By Chris Hill – Updated Oct 21, 2019 at 7:47AM

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Letting the cloud pass by looks more like a fatal error for IBM every quarter.

In this episode of MarketFoolery, host Chris Hill and Motley Fool analyst Bill Mann chat about some business news. Shares of Netflix (NFLX 1.93%) oscillated after the company reported a mixed bag of a quarter. Meanwhile, IBM's (IBM -0.38%) sales fell for the fifth quarter in a row, and things are looking grim for the gigantic company. And Brexit may finally be moving along in a big way, given a new proposal to resolve the Irish border problem, but we'll have to wait and see what comes next. How should investors account Brexit into their U.K. investing strategy? Tune in to learn more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

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This video was recorded on Oct. 17, 2019.

Chris Hill: It's Thursday, Oct. 17. Welcome to MarketFoolery! I'm Cris Hill. With me in studio, Bill Mann. Thanks for being here! We have a possible deal on Brexit. We have a possible third act for a business giant. But we're going to start with Netflix today. Third quarter results are in. Shares of Netflix up about 5% as we walked in the studio. I timestamp it that way because at various points in the morning, they've been up and down. I think this is the textbook mixed quarter. Profits were better than revenue. International subscriber growth --

Bill Mann: Really good.

Hill: -- better than domestic.

Mann: Netflix, and I think this is true of a lot of companies, and I love the fact -- you're exactly right, the stock has moved about 10% from top to bottom so far this morning. By the way, that means to market cap has swung $30 billion this morning. Yeah, the quarter was good. I think Netflix has done quite well overseas, where they don't necessarily have the same competitive pressures that are coming down the pike. When you say it's a mixed bag, for the long term for Netflix, they really are starting to talk about how much competition they are getting ready to face. Amazon's been there a long time with Prime. Apple is coming down the pike. Disney is coming down the pike. They're admitting that they're seeing it already.

Hill: You saw the note from Reed Hastings and his team referring to, "modest headwinds" was the phrase that stuck out to me. And I think that's being very clear-eyed.

Mann: I think he's right.

Hill: Yeah, it's one of those things where I'm like, yeah, that seems right. If you're a Netflix shareholder, you have to appreciate that you have a very clear-eyed CEO who's saying, in the near term, there are modest headwinds, in part because of Disney+ coming on board, Apple -- it's hard for me to say Peacock, but, Peacock --

Mann: [laughs] Kabbage! They should have named it Kabbage!

Hill: Yeah. NBC counting on some hidden great affinity for the peacock logo of yesteryear. Anyway, again, I think Hastings is right when he says, "Yeah, over the next six to 12 months, there's going to be a lot of noise; there's going to be a lot of people paying attention to these new services; maybe our service takes a little bit of a back burner." But long term, he feels good about the business, and he's earned that right.

Mann: They have great properties. I don't have the stat right here in front of me, but Stranger Things was watched in its first week by, what, 64 million people, is that right?

​Hill:​ Something like that.

​Mann:​ Let's just say that's right. It's a lot. One of the things that bothers me about the Netflix story right now is that they are saying that they expect to get about 300 basis points, so about 3%, of added margin over the next year. I don't see how they get there. I really don't, with competition coming down the pike. Now, it is the case with entertainment that it's not just the fact that competition shows up. Stranger Things results will tell you that the titles are everything. But if the titles are everything and you're seeing rising costs in the production, and procurement of those titles, I have a hard time seeing how they're going to generate much in the way of margin expansion. 

Hill: How do you think they are thinking they get there? It can't be primarily through price increases, can it?

Mann: Not in this environment -- I mean, not domestically. 

Hill: I mean, in theory, yes they could. 

Mann: [laughs] Right, we all could. "Everyone, send us $1. See? We've done it!"

Hill: But, given everything we've just said, and Reed Hastings admitting, like "Yeah, these new services are coming online," and left unsaid by Hastings, but we can say it -- they're priced lower. They're priced to move. 

Mann: There's a lot of wreckage out there in the markets for people who have doubted Reed Hastings over time. I'm not saying I know his business better than he does. If he says he sees 300 basis points in margin expansion, he sees something. But I have a hard time from this standpoint seeing what it is, given how the environment has changed.

Hill: We'll see how that goes. And we'll move on to IBM. IBM's third quarter --

Mann: Eh, they did some things.

Hill: Yeah, it's the classic "beat by a penny, and absolutely no one cares," because for the fifth quarter in a row, sales fell. I don't want to get into the weeds on IBM's business. But here's what is of interest to me. IBM has been around for so long, and there have been multiple stretches of time where, if you were an IBM shareholder, you were incredibly happy, because that was a business that was doing really well. I ran through some of the numbers. 1994 through 2001, the stock was up more than 800%. And then, when it looked like, it's now this legacy business and they're not going to be able to grow, they had another four or five-year stretch of time -- 2009 through about 2013 -- where the stock nearly tripled. And it really was like, oh, my goodness, they've done an amazing job of --

Mann: Reinventing themselves.

Hill: -- reinventing themselves. When you're a company that size, that's really hard to do. Since then, this stock has faded to the tune of like 40% over a six-year period.

Mann: I think the word that probably gives nightmares to anyone who has been a long-term IBM shareholder, and probably management, is cloud, because they missed it. The thing that's amazing -- as I was doing some research for today, I just typed in the words "the death of IBM." And an article from 2015 from Forbes called The Death Of IBM came up. And It was a really amazing opening. They said, "The key areas of data storage, security, are completely up for grabs." Everyone knew, and they were right. It was completely up for grabs. And I think that IBM just simply had legacy businesses that it wanted to protect. And this happens all the time with really large companies that see the tail end of whatever it is that they were doing being particularly impactful, they have to find a new thing, but a lot of companies find it really hard to move away from what they were doing. I was going to use a more violent term than that, but let's just say to get away from what they were doing. And IBM failed. I really don't see how they come back at this point.

Hill: You just reminded me of the great story about Andy Grove when he was at Intel. I forget what legacy business it was, but there was some part of Intel's business that for years and years was just printing money hand over fist. And it was starting to slow down. And Grove turned to his right hand man. They were wrestling with this issue of, "What do we do? Do we shut this thing down? Do we move into this other area where we know it's going to be good?" The money they were making at the time was almost too much to ignore. And finally, Grove hit upon this idea. He says to his right hand man, "What if you and I got fired and they brought in two new people? What would they do?" And his guy was like, "Oh, they would shut this thing down and work on the new thing." And he was like, "Great! Let's fire ourselves, walk in the front door again, and let's do that."

Mann: "Let's be the new guys!"

Hill: And it sounds like you just answered the question I teased at the top. I look at the run IBM has had, and the run that the business had and that the stock had starting in 2009, that was unexpected, making the Forbes article pretty prescient, because that comes about a year on the heels of a really good run for IBM. You go back seven years, and this company is worth somewhere in the neighborhood of $215 billion. Now, it's like $125 billion.

Mann: And they were selling mainframes. They were selling mid-range systems. It was a great time for them. They actually shifted quite well. This really, once again, describes to me how powerful good management is. We look at another company that probably five or six years ago -- let's call it 2015, also, although it was probably a little bit earlier -- was a little bit in danger of being in the same spot. That was Microsoft. Microsoft had the same issues that it was facing. And we didn't even know at the time that even Office was going to be under threat. And Satya Nadella, he shifted. He shifted the entire business. And now, Microsoft is, or at least has been -- I don't know about today -- the largest company in the world by market cap once again.

Hill: Not a small business. But when you own a small business, your time is valuable because you're doing it all. You're managing inventory, covering payroll, you're doing 100 other things before lunch. And that's just the typical day. Getting the money you need to run your small business should not be the thing that takes up all your time. These are issues that Mr. Nadella doesn't need to worry about because he's running Microsoft. 

The big international news this morning is the potential -- or, I should say, the draft agreement on Brexit. You look outside the United States far more than I do when it comes to the world of investing. Is anything about this deal striking to you, either in good ways or bad?

Mann: Most of it is entirely nearly the same of what they've been talking about before, but the big issue that they've had -- and I would not call this settled -- is what to do with Ireland. Northern Ireland and Ireland have no physical border in between them. You can move back and forth, and literally the only thing that you notice is that the street signs change just a little bit in terms of their format. Goods move across the border. This has been a really, really big deal for Ireland as well as Northern Ireland, both from an economic standpoint as well as just simply an emotional one, a political one. 

The new plan actually moves the British customs to in-between Northern Ireland and Great Britain itself. So there would be a customs check going from Scotland, say, or England or Wales, into Northern Ireland, and then a free flow within on the island between Northern Ireland and Ireland. The primary Northern Irish political party, as you might imagine, doesn't like this very much. So there is still a vote to happen. They very well may scuttle the entire thing, in which case, we will be back to square one. But this is the solution now. And I don't want to bring it up as a good example of a place where this has worked, but between China and Hong Kong, there's been a customs check. Maybe that's the worst thing I could possibly say. Like, "Hey, it works in Hong Kong!" while they're lighting things on fire. But, it's possible they've come up with a solution that seemed reasonable all along, but on the ground, there are a lot of political and emotional issues that might stop it.

Hill: Is the uncertainty of Brexit enough of an X factor that when you're looking to markets outside the United States, that just moves that whole region further down the list? You're looking to other parts of the world before you look there?

Mann: Honestly, not really.

Hill: It's still about the businesses?

Mann: It's still about the businesses. There are good growth companies in the United Kingdom. There are in Ireland. There are in Germany. We visited an unbelievable company called Adyen when we were in the Netherlands. All of these companies would conceivably be impacted by Brexit. But you know what? Every company that does anything outside of its borders is also impacted not just by Brexit, but any types of international negotiations that take place anywhere in the world. It's not like we're Pollyanna-ish about and say, "Well, good things will happen." Good things might not happen. But I've yet to find a good reason long term to really put too much into trying to predict what's going to happen from a political standpoint.

Hill: Let me tell you what might happen as early as Friday -- the United States imposing a 25% tariff on a number of goods from the EU, including scotch whiskey.

Mann: This is such a mistake. This is such a mistake! Is it horrible for me to say that from now on, we need to have a president who drinks? He or she will know just how bad this is.

Hill: I knew I was going to bring this up, and I meant to check before coming in the room, how a business like Brown–Forman is trading today. I'm wondering, if you own bourbon stocks, is this a boon for you? Potentially a boost. I'll just say that in my own shopping habits, if the cost of scotch whiskey goes up 25%, I'll just tell you, I'm less likely to buy scotch whiskey. 

Mann: That's right. We have alternatives. Now, that's not to say that the tariff hasn't happened before, but when you're dealing with international trade, we have had a similar issue not that long ago in which the euro spiked against the U.S. dollar. The pound sterling did as well. Prices move. But 25% just feels like an own goal to me. Can't we just have this?

Hill: By the way, it's one of those things that maybe you learn about in high school American history class, if you take something in college, maybe you learn about this; I was very much into my adult years before I fully comprehended, during George Washington's presidency -- Washington, the father of our country -- the Whiskey Rebellion. And understanding the implications of, George Whiskey -- 

Mann: "George Whiskey!" [laughs]

Hill: George Washington! [laughs] Exactly. George Washington, who made a lot of money selling whiskey, as president, sent troops to basically quash whiskey makers in other states. And it was like, "Wait a minute... wait... huh?" So, Washington, who we hold up as this ideal -- yeah, there was a little bit of a conflict of interest there with George!

Mann: But I agree with him. He's like, "Can't I just have this one thing?"

Hill: I mean, if that's the worst thing you could say about George Washington, maybe -- but, it's like, yeah, there was a little bit of a conflict of interest there with George. 

Mann: Yeah, true fact.

Hill: Bill Mann, thanks for being here!

Mann: Thanks, Chris!

Hill: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That'll do it for this edition of MarketFoolery! The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you on Monday!

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. Bill Mann has no position in any of the stocks mentioned. Chris Hill owns shares of Amazon and Walt Disney. The Motley Fool owns shares of and recommends Amazon, Apple, Microsoft, Netflix, and Walt Disney. The Motley Fool owns shares of Intel. The Motley Fool is short shares of IBM and has the following options: long January 2021 $60 calls on Walt Disney, short January 2020 $200 puts on IBM, short January 2020 $50 calls on Intel, short January 2020 $155 calls on IBM, short January 2020 $155 calls on Apple, long January 2020 $150 calls on Apple, short January 2020 $155 calls on Apple, long January 2020 $200 calls on IBM, long January 2020 $150 calls on Apple, and long January 2021 $85 calls on Microsoft. The Motley Fool has a disclosure policy.

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