When oneabout blue chip tech stocks, "Big Blue" IBM (NYSE:IBM) is always one of the first companies that comes to mind. While some investors might think of IBM as a "buy it and forget it" dividend stock which should at least keep pace with the market, it's actually underperformed the S&P 500 over the past five years.
When I take a closer look at IBM, I see a confused company with stagnant top line growth, a "slash and burn" approach to its businesses, and muddy plans for the future. That being said, let's talk about why IBM is one blue chip stock I'd never buy.
IBM's identity crisis
Last year, IBM's revenue fell 4.6% as its net income slipped 0.7%. Last quarter, revenue from continuing operations fell 4% year-over-year -- its tenth consecutive decline -- as net income fell 17%.
IBM's strategy over the past decade has been the same -- to sell off lower margin or non-performing businesses. The company sold its PC and x86 server businesses to Lenovo (NASDAQOTH:LNVGY), its U2 database business to Rocket Software, its point-of-sales business to Toshiba TEC, and its customer care unit to Synnex (NYSE:SNX). IBM also quietly abandoned its SDN (software networking defined) business earlier this year and paid Globalfoundries $1.5 billion to take its unprofitable chip manufacturing unit in October. While these strategies protected IBM's bottom line over the past five years (until last quarter), they barely improved its top line growth.
IBM is heavily banking on the cloud to eventually offset losses from its other businesses. Last year, IBM acquired SoftLayer Technologies for $2 billion to expand its cloud-based footprint, then committed an additional $1.2 billion to expand its data centers and services. It also invested $1 billion in creating a new business unit for Watson, its Jeopardy-playing AI which can quickly analyze cloud-based data. Unfortunately, the cloud business simply isn't growing fast enough. During the third quarter, IBM's cloud offerings had an annual run rate of $3.1 billion, up from $2.8 billion in the second quarter. But that's a drop in the pond for a company which reported nearly $100 billion in revenues last year.
Meanwhile, IBM's core businesses are mostly posting declines. Sales from its global services segment, which accounts for 61% of its top line, fell 3% last quarter. Its backlog also slipped 7% year-over-year, indicating that competitors like Accenture (NYSE:ACN) are taking a bite of its business services market. Sales of software, which account for 25% of IBM's revenue, also dropped 2% as demand for its middleware products dried up.
The $20 promise
Former CEO Sam Palmisano's introduced his "Roadmap 2015" plan in 2010, which set the five-year goal of doubling earnings per share from $10.01 in 2009 to $20 by 2015. The plan sounded so solid that Warren Buffett invested $10 billion in the company in 2011, despite his well-known aversion to tech stocks.
Unfortunately, that plan resulted in a blind dedication to grow its bottom line, at any cost, without long-term plans (besides the cloud) for top line growth. IBM also increased stock buybacks, but they were funded by debt, causing its long-term debt to spike over the past five years:
The big problem with Palmisano's $20 promise was that he made it at a time when IBM was streamlining its business for growth. Therefore, instead of buying back shares ($13.9 billion in 2013), IBM should have acquired more cloud-based companies to accelerate the growth of its cloud business. Ginni Rometty, who succeeded Palmisano in 2012, recently continued that tradition by boosting IBM's buyback plan by $5 billion after its dismal third quarter earnings. Looking ahead, IBM reduced its free cash flow forecast from $13 billion to $12 billion for the year. It will also cut additional jobs, which will result in a fourth quarter charge of up to $600 million.
But most importantly, IBM abandoned Palmisano's $20 promise, only stating that it would provide an updated 2015 forecast in January.
The road ahead
Over the next few years, IBM will likely endure more top and bottom line declines as it struggles to appease shareholders with buybacks while hoping that its investments in the cloud pay off.
There are bright spots on the horizon, including its partnership with Apple (NASDAQ:AAPL), which helps its cloud-based services piggyback on iPads into more businesses, and Watson's rising profile in hospitals, but they simply aren't enough to offset IBM's core problems. IBM might eventually bounce back if it invests more in inorganic growth instead of burning all the furniture, but I just don't see that happening under the current management.
Leo Sun owns shares of Apple. The Motley Fool recommends Accenture and Apple. The Motley Fool owns shares of Apple and International Business Machines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.