IBM (IBM -0.15%) will release its quarterly report on Tuesday, and the stock has been the most disappointing member of the Dow Jones Industrials over the past year, having been the sole Dow component to lose ground in 2013. Yet despite every indication that IBM's revenue weakness will continue, IBM earnings continue to grow, and Big Blue hopes to keep its momentum going against Hewlett-Packard (HPQ -1.36%), Oracle (ORCL), and its other rivals in the tech industry.
IBM made a smart move when it started years ago in diversifying its business beyond its initial hardware focus, helping it avoid the fate that has really hurt Hewlett-Packard by incorporating higher-margin services and consulting work into its business mix. But with a new CEO on board, 2013 was a difficult transitional year for IBM, and weakness in overall information-technology spending among enterprise customers has made competition between IBM, Oracle, HP, and other industry players that much fiercer. Can IBM turn 2014 into a banner year? Let's take an early look at what's been happening with IBM over the past quarter and what we're likely to see in its report.
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Will IBM earnings keep climbing despite falling revenue?
In recent months, analysts have cut their views on IBM earnings somewhat. They've reduced their fourth-quarter estimates by $0.03 per share and cut their full-year 2014 projections by three times that amount. The stock has finally found a little traction, rising 3% since mid-October.
IBM's third-quarter report explains a lot about why the computer giant has struggled so much lately. Even though the company's earnings managed to top expectations, revenue was about $1 billion below what investors had expected to see. One of the biggest problems came from the systems and technology segment, which suffered a 17% drop in sales from the year-ago quarter. That comes largely because of greater enterprise use of cloud computing, with virtual solutions making it less necessary for customers to build their own infrastructure and buy their own servers. Some believe that IBM is too focused on earnings per share, with gimmicks like tax-rate reductions and massive stock buybacks sending EPS higher while masking weakness in other metrics.
But IBM is fighting back against Oracle, Amazon.com (AMZN 2.08%), and other major cloud players. The company said last week that it would spend $1.2 billion on building new data centers around the world, adding 15 centers to its existing network of 25 data centers as part of an ongoing initiative to cover the entire world in the next couple of years. In addition, IBM invested $1 billion toward a division centered on its Watson system, hoping that it can help IBM compete against Oracle and HP in the big-data and business-analytics areas, which have become increasingly important to enterprise customers seeking to draw profitable conclusions from the data they collect. With expectations of turning Watson into a $10 billion business, IBM hopes to differentiate itself against Oracle in order to justify high-margin sales of related services and products.
Nevertheless, competition is getting tough. Hewlett-Packard managed to grow its market share in the server industry over IBM, even though HP likely cut its prices in order to spur switching. Moreover, Amazon has seen a lot of success from its commodity-based cloud-services division, forcing IBM to focus on higher-margin premium services that require more of a long-term commitment from customers.
In the IBM earnings report, look beyond earnings per share to look at where net income and revenue actually come from. If IBM expects to succeed not just in hitting its $20 per share earnings target in 2015 but also produce lasting growth potential, it needs to succeed in its more innovative initiatives at building up higher-margin businesses.
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