As 2014 draws to a close, shares of International Business Machines (IBM 1.11%) sit at a multiyear low. The relentless earnings growth of the past decade is no more, with earnings set to decline this year and the original target for 2015 pulled without a replacement. The market is pricing in a bleak future for IBM, one in which the company gets left behind, unable to adapt to a rapidly shifting IT landscape. But, much like it has done in the past, IBM is transforming itself, and while the near future will likely be choppy for the company, there are big opportunities ahead in 2015 and beyond. Here are some things investors should be watching as the calendar turns.
Big Data is IBM's next great business
The last great transformation that IBM went through was the result of the near-collapse of the company in the early 1990s. IBM's mainframe business was upended by the PC and server, and huge losses followed. A new CEO was brought in, and the company was set on the course that has led it to become the software and services powerhouse it is today.
The situation isn't nearly as grim now as it was in the '90s. The cloud is certainly changing the IT market, but IBM doesn't have the same vulnerability it had 25 years ago, when hardware sales were the driving force behind its business. And while the cloud is forcing IBM to adapt, it's also opening up new opportunities for the company.
Big Data, a term that describes data sets so large and complex that traditional data processing methods are insufficient, represents IBM's best chance at growing its business going forward. Collecting these massive sets of data is the easy part; the hard part is analyzing them and drawing meaningful, actionable insights from the deluge of information.
IBM has already launched products aimed at the Big Data market, with the most notable being Watson, the natural language system that won Jeopardy a few years ago. Watson is now a service delivered over the cloud, and it's already being used in a variety of industries. In October, IBM signed a deal with Twitter that integrates Twitter data with Watson, allowing businesses to analyze trends that may have otherwise gone unnoticed. Twitter's data is a perfect example of the kind of complex, unstructured data that IBM's Watson was built for.
Another application of Watson can be found in the medical field. Earlier this month, IBM announced a multiyear deal with the U.S. Department of Veterans Affairs to use Watson to sift through and analyze the enormous quantity of medical records handled by the agency, with the ultimate goal of providing more efficient and higher-quality care. According to IBM, the amount of medical data in existence doubles every three years, presenting a challenge that can only be solved with advanced systems like Watson.
The potential impact
When IBM launched the Watson business at the beginning of this year, CEO Virginia Rometty stated that the goal was to turn it into a $10 billion business within 10 years. This is certainly a lofty goal, and Watson is still a very minor part of IBM today, but the potential is truly enormous. IDC forecasts the Big Data technology and services market to grow at a 26% compound annual growth rate through 2018, with the size of the market expected to reach $41.5 billion at that time.
IBM's transformation won't happen overnight, and investors should be prepared for another rough year for IBM in 2015. I do expect to see a lot more deals being announced involving Watson and Big Data from IBM next year, but it's still a small part of IBM's business, and the company's earnings will continue to be dominated by traditional software and services, as well as the remaining hardware segments left over after the purge of 2014.
What IBM's earnings will be in 2015 is a mystery at this point. The company is expected to provide guidance when it reports its fourth-quarter earnings in January, but its prior guidance for 2014 proved to be wildly optimistic. It's very possible IBM's earnings will decline in 2015, as they are expected to do in 2014.
Despite these issues, IBM is on the ground floor of what could be a business that eventually brings in tens of billions of dollars in revenue. The story of IBM is one of transition, with the company exiting businesses where it can't maintain a competitive advantage, and investing in those where it can. 2015 will be no different, and investors should keep an eye on the progress IBM makes in growing its Big Data business. It's the key to IBM's future.