IBM's Steady Recovery Continues

Investors should keep in mind that IBM's recovery will take more time. However, a path to future growth is clear.

Bob Ciura
Bob Ciura
Apr 22, 2014 at 2:15PM
Technology and Telecom

Technology giant International Business Machines (NYSE:IBM) released first-quarter earnings that, while unspectacular, confirmed that the company is on track for future growth. IBM's revenue has declined for several quarters, and this most recent earnings report was no exception. The company still hasn't gained a solid foothold in the emerging markets, and its transition to a leadership position in the cloud has yet to fully materialize.

Still, IBM is making significant progress, and investors shouldn't lose sight of that. The main takeaway for investors now that IBM is out with results from the first quarter is that 2014 is off to a slow start, but growth is on the horizon.

IBM by the numbers
In all, IBM posted a 1% drop in revenue on a constant-currency basis. Revenue dropped 4%, but IBM was punished by the strengthening U.S. dollar. Stripping out currency effects reveals a fairly steady quarter. Obviously a revenue decline is never good news, but this performance was much better than the 3% revenue decline in the previous quarter.

Importantly, IBM performed much better in the emerging markets, where the company is counting on as a future growth engine. IBM's first-quarter revenue in the BRIC nations -- Brazil, Russia, India, and China -- fell 6% when adjusted for currency fluctuations. This was marked improvement from the fourth quarter, when its revenue dropped 11%, even when removing the effects from a stronger U.S. dollar.

IBM, like many other technology giants, is looking across the globe to grow its business, as growth in the United States has leveled off. After its poor performance in the fourth quarter, IBM Chief Executive Officer Ginni Rometty traveled to China to improve her company's standing there.

Software and the cloud are the keys
Going forward, IBM clearly wants to derive more of its business from software than it used to. For many years, IBM was a near pure-play in hardware. Over time, the company has switched focus. This, of course, has been a difficult transition, due to the very nature of IBM's huge size. A $200 billion company by market value doesn't turn on a dime, and IBM's profits have suffered from the associated costs.

IBM took $870 million in restructuring charges in the first quarter, which resulted in a 21% drop in GAAP profits. However, the transition is beginning to materialize on the top line. Revenue from IBM's middleware products, which include offerings like WebSphere, Information Management, Tivoli, and Workforce Solutions, rose 5% to $3.7 billion in the quarter. In addition, IBM's cloud revenue soared by more than 50% in the first three months.

Refocusing on cloud solutions has worked extremely well for some technology giants that were wise enough to see its potential. For example, Microsoft (NASDAQ:MSFT) posted record revenue in the most recent quarter, thanks in large part to its cloud-based business. Its commercial cloud services, which include Office 365, Azure, and Dynamics CRM Online, more than doubled quarterly revenue, year over year. More broadly, the move away from hardware has proven to be a profitable strategy. Microsoft's SQL Server business gained market share in the last three months. It and the System Center division posted double-digit revenue growth.

The bottom line
IBM's earnings report doesn't look spectacular on the surface. Its revenue fell in the quarter, and it's still taking huge charges as it restructures its workforce. At the same time, there are glimmers of hope appearing in IBM's reports. The charges are a one-time issue that should not recur once the process is complete, and its performance in the emerging markets is improving.

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IBM is certainly not out of the woods. Management maintains a relatively ambitious growth strategy over the long term. That includes a forecast for $20 in earnings per share by next year. The company can certainly get there, but the pressure is on to keep improving across its software and cloud-based services.