I first bought shares of International Business Machines (NYSE:IBM) a few months ago after a disappointing earnings report sent the stock tumbling, and I previously wrote about my reasons for investing in the company. The stock has remained depressed since then, and I recently bought even more shares of IBM, taking advantage of the extreme pessimism swirling around the company. To me, all of this doom-and-gloom talk seems overdone. Here are two reasons why I'm loading up on more shares of IBM.
Getting rid of what doesn't work
IBM is not the kind of company that goes after revenue growth at all costs. It routinely gets rid of businesses where it no longer has a meaningful competitive advantage, continually shifting toward higher-value products and services. The moves that IBM made in 2014 followed this strategy to a tee, allowing the company to rid itself of empty revenue.
IBM got rid of two big businesses last year. First, it sold its x86-based server business, System X, to Lenovo. Lenovo is the same company that IBM sold its PC business to more than a decade ago, and while Lenovo has since grown to become the leading PC vendor in the world, its razor-thin margins show that IBM ultimately made the right call.
The x86 server business is very similar to the PC business. The vast majority are powered by Intel processors, and there's very little differentiation between different server vendors. What's more, large Internet companies are increasingly designing their own Intel servers, cutting out the middleman completely. Staying in the x86 server market for the sake of revenue growth would have been a foolish strategy, and IBM was right to sell the business.
The second business IBM got rid of was its semiconductor manufacturing business. IBM actually had to pay GlobalFoundries to take the money-losing business off its hands, and IBM will use the company as its exclusive server processor provider for the next 10 years.
IBM simply didn't have the volume to support this business, and getting rid of it eliminates a significant source of losses. IBM is still designing its own processors, built on its Power architecture, but it will no longer be manufacturing them directly.
Mindlessly growing revenue without regard to profitability is not what IBM is about, and while IBM's shrinking revenue seems to be a concern to some, earnings are the ultimate gauge of success. Over the past decade, while IBM's revenue stagnated, net income doubled. While the past two years have been difficult for IBM, shedding the x86 server and semiconductor manufacturing businesses are important steps in IBM's efforts to return to robust earnings growth.
Focusing on what matters in the cloud
IBM was certainly not the first company to embrace the cloud. As with any new technology, those with entrenched positions tend to be slow to adapt, and it took a while for IBM to get serious. IBM acquired SoftLayer in 2013, a cloud computing company offering infrastructure-as-a-service, or IaaS, and IBM has built its cloud platform on SoftLayer's infrastructure.
While cloud infrastructure, such as virtual machines and storage, has largely become a commodity, with prices continually slashed by the major players, IBM's focus is on using the cloud to deliver solutions. This is really what IBM has always been doing through its massive software and services businesses, but the cloud provides a new way to deliver solutions to its customers.
IBM's Bluemix is the cloud platform that IBM built on top of SoftLayer's infrastructure, and it provides a platform-as-a-service, or PaaS, aimed at enterprise developers. What makes Bluemix unique is that it exposes IBM's software and middleware as a service, allowing developers to tap into IBM's ecosystem.
One example of such a service available to developers is Watson, IBM's cognitive computing system that won Jeopardy a few years ago. IBM is betting big on Watson, investing $1 billion in the business in 2014, and along with all of the other services available on Bluemix, IBM is hoping that it can provide a unique platform that provides value to businesses and organizations.
It's important to understand that the cloud is not a solution unto itself. The cloud is simply a new way to deliver software and services, and while IBM's transition is unlikely to be smooth, the competitive advantages that the company currently has should carry over. IBM is one of the top three software vendors in the world, and the reason is because its software provides value. The cloud doesn't change that.
The cloud computing market is still very young, and IBM's focus on building a robust platform is likely the right strategy. Fighting over IaaS customers is unlikely to lead to the kinds of profit margins that IBM is used to, and the focus on providing solutions over the cloud, leveraging its vast portfolio of software, gives IBM the best chance of profitably growing its cloud business.