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IBM Job Cuts: A Painful Necessity

By Tim Brugger - Mar 2, 2014 at 12:15PM

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Rumor has it the IT giant is planning to cut as many as 15,000 jobs to better align itself to a shift in business priorities.

For many Americans, the sting of a recent recession, double-digit unemployment, and skyrocketing foreclosure rates are more than just a bad memory, they're still digging themselves out of the hole all that negativity put them in. With that said, the notion that one of the world's most recognized companies is rumored to begin a series of firings could be a bit depressing.

But before you lambast IBM ( IBM 1.18% ) for trimming overhead, in this case by paring jobs from its global workforce of more than 431,000, assuming the rumors are true, there's some method to CEO Ginni Rometty's madness. In the long run, painful as it might be, streamlining overhead in a declining business unit will benefit both IBM and its shareholders.

What's the point?
Rometty made it clear from the day she took the helm of IBM two years ago that she had an aggressive earnings target in mind: By 2015, Rometty and team want to deliver earnings of $20 a share. At its current share price of slightly over $185, $20 a share in earnings equates to a forward price-to-earnings ratio of just over 10, which would make IBM an even bigger steal for long-term value investors than it already is. Of course, targeting an aggressive earnings figure, and actually accomplishing it, are two different things entirely.

When IBM announced 2013 Q4 and annual earnings on Jan. 21, its stock took a beating, dropping from $190.09 a share the day before the announcement, and declined steadily over the next two weeks to bottom out at 172.84 a share by Feb. 4. The culprit? A couple of things.

Last quarter, to investors' dismay, IBM kept its string of declining revenues intact, dropping 5% compared with the year-ago quarter to $27.7 billion. Without delving into what IBM is trying to accomplish long-term, which many investors don't seem willing or able to do, that kind of negative revenue string would seem to substantiate the Street's bearish outlook.

In addition to some negative investor sentiment, analyst's also put pressure on IBM's stock price, noting the decline in revenues and bemoaning the often-mentioned erosion of the computer hardware industry, IBM's former bread-and-butter. Though its business analytics unit revenues were up 9% compared with the year prior, and cloud revenues jumped a whopping 69% in 2013 to $4.4 billion, IBM naysayers chose to focus on hardware and overall revenues. Too bad for them.

Thing is, Rometty and IBM made the decision some time ago to change its focus, shedding the dark blue suits and red power ties of the old IBM and entering the 21st century, which takes time. Unfortunately, such a major shift in business strategy also means that once large, significant revenue-generating divisions like hardware are no longer IBM's impetus for growth. The result? Though a small percentage of IBM's overall workforce, a number of people will be out of a job soon.

Word has it
Depending on which rumor you choose to believe, IBM will let go around 25% of its systems and technology group. Some have put the figure of the soon-to-be-displaced workers between 13,000 and 15,000, though IBM won't comment on specifics. The systems and technology group is where IBM's hardware unit resides, and it nose-dived again last quarter, down 26% compared with 2012's Q4 to $4.3 billion. Clearly, IBM's hardware unit, like the overall market, is floundering, and it's time that situation is remedied.

Final Foolish thoughts
It's an unfortunate truth: Reaching $20 a share in earnings is going to require IBM to address both the top and bottom lines. In other words, simply cranking up revenues in its fast-growing cloud, big data, and cognitive computing businesses isn't enough. Re-aligning its assets, and that includes IBMers, to fit its new business focus means some folks will be out of a job. For investors, IBM's streamlining efforts and inroads into burgeoning markets make it one of the best long-term investments you'll find.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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