IBM’s New CEO Faces a Trial by Fire

IBM's (IBM -8.94%) stock recently dipped after the tech giant reported mixed first-quarter earnings. Its revenue fell 3% annually (roughly flat after excluding divested businesses and currency impacts) to $17.6 billion, missing estimates by $50 million.

Its non-GAAP earnings declined 18% to $1.84 per share, but still beat expectations by four cents. The company also pulled its full-year outlook, citing COVID-19 headwinds, and stated it would reassess its position "based on the clarity of the macroeconomic recovery at the end of the second quarter."

Image source: Getty Images.

This marks IBM's final quarter under CEO Ginni Rometty, who was succeeded by former cloud and cognitive software chief Arvind Krishna in early April. However, Krishna could face a trial by fire over the next few quarters -- the tech giant faces tough competition in the cloud market, and brutal macro headwinds.

IBM's weaknesses still outweigh its strengths

Under Rometty, IBM divested weaker businesses and acquired stronger businesses in the cloud, analytics, mobile, and security markets. Its acquisition of Red Hat for $34 billion last year marked its biggest deal ever.

Rometty tried to offset the sluggish growth of IBM's legacy software, hardware, and IT services businesses with its higher-growth cloud-based businesses. But that balancing act has been tough, and its weaker businesses offset those gains during the first quarter.

Source: IBM Q1 earnings report. Constant currency terms.

Another slowdown in its cloud infrastructure business

IBM's decline in global technology services (GTS) was especially disappointing, since it houses the cloud infrastructure business that competes against Amazon (AMZN -2.37%) Web Services (AWS) and Microsoft's (MSFT -3.14%) Azure.

Within that business, IBM's GTS cloud revenue only rose 12% annually. By comparison, AWS and Azure's revenues rose 34% and 62% year-over-year, respectively, in their latest quarters.

During the conference call, CFO Jim Kavanaugh stated that IBM would "evaluate the cost competitiveness" of its GTS portfolio, restructure the unit to cut costs, and integrate it with its global business services (GBS) unit to gain more customers. Nonetheless, it's becoming increasingly difficult for IBM to compete against AWS and Azure, which lead the global cloud infrastructure market by a wide margin.

Not enough growth in its other businesses

The growth of IBM's cloud and cognitive software unit, which houses Red Hat and its other cloud, AI, and IoT (Internet of Things) services, also decelerated from its 9% growth in the fourth quarter.

Kavanaugh noted the unit was generating double-digit revenue growth through February, but "stalled nearly overnight" in March as the pandemic shut down entire sectors. Specifically, IBM had expected several "transformation deals" in the retail industry, but many of those deals have been paused.

Image source: IBM.

IBM's systems revenue growth also decelerated from its 17% growth in the fourth quarter. Mainframe sales continued to rise as big enterprise clients upgraded their systems, but its sales of Power Systems -- which are geared toward pandemic-impacted smaller companies -- fell and partly offset those gains.

IBM's new CEO hasn't offered much clarity... yet

Unlike Ginni Rometty, who rarely joined conference calls with analysts, Arvind Krishna joined Big Blue's fourth-quarter call. However, Krishna's comments were somewhat vague and sounded like a continuation of Rometty's strategies.

Krishna stated he wanted IBM to lead "two transformational journeys" in the cloud and AI markets via its mainframe, services, middleware, and hybrid cloud platforms. He also declared that the development of new services with Red Hat would help IBM win the "architectural battle" for the hybrid cloud market, which blends together private and public clouds for companies that aren't ready to move all their data off-site.

But we've heard this argument from IBM, which views the hybrid cloud as a defensible niche against AWS and Azure's public platforms, countless times before. Krishna stated that he would focus on "better aligning" IBM's portfolio with the hybrid cloud and AI markets via investments, acquisitions, and divestments of non-core businesses -- but that doesn't sound too different from Rometty's approach yet.

But don't jump to conclusions

In short, investors who were waiting for a big transformation, as Satya Nadella seeded at Microsoft with his "mobile first, cloud first" mantra, were likely disappointed. However, it's still far too early to tell how Krishna will steer IBM over the long term.

If Krishna survives IBM's trial by fire over the next few quarters, he might unveil fresh strategies to counter Amazon, Microsoft, and other cloud-based rivals. For now, investors should assume that IBM will tread water in the near term, but it could eventually swim forward again with a new CEO at the helm.