It is a mantra that goes back decades: "Nobody ever got fired for buying IBM (NYSE: IBM)." For an company executive, selecting IBM as a supplier was the safe option. But what of buying IBM's stock today? Two of our Foolish analysts argue that IBM may not be as safe as you think.
Tim Green: There are parts of IBM's business in which the company has distinct, durable competitive advantages. Mainframes are one example, since customers have little choice and little reason to move away from IBM's proprietary hardware.
But future growth isn't going to come from those types of businesses. IBM doesn't expect its core businesses, which account for the bulk of its revenue, to grow at all in the coming years. Instead, growth will come from businesses that IBM has dubbed strategic imperatives, a group that includes cloud, analytics, mobile, social, and security products.
The largest of these imperatives is analytics, already a $17 billion business for IBM, including hardware, software, and services. In 2014, IBM's analytics business grew by 7%, and the company expects continued growth going forward. One of the most high-profile IBM analytics products in recent memory is Watson, the cognitive computing system the company used to win Jeopardy in 2011. IBM invested $1 billion in Watson last year, and the company hopes the service will generate $10 billion in revenue within the next decade.
But IBM isn't the only company hoping to turn the machine-learning technology behind Watson into a cash cow. Microsoft has been aggressively building out its Azure cloud platform in recent years, and earlier this year, the company launched its own Watson-like service: Azure Machine Learning. The goal of both Watson and Azure Machine Learning is to take in an enormous amount of data, both structured and unstructured, in order to generate insights.
One of the biggest risks for IBM going forward is that competition, from the likes of Microsoft and other cloud companies, derails its efforts to return to growth. The cloud has drastically lowered the cost of entry for services like Watson and Azure Machine Learning, removing the need for expensive hardware. While this broadens the potential customer base, it also makes it easier for competitors to offer similar products.
For IBM's stock to recover, the company needs to show it can return to growth. The worst-case scenario is that revenue and profits stagnate or even decline, with the strategic imperatives pressured by competition. I believe IBM can eventually right the ship, but it's certainly no guarantee.
Alex Dumortier: The risk I want to highlight isn't an immediate threat, but one that could materialize if IBM's strategic reorientation stalls, and it's something investors need to continue monitoring.
So far, IBM has remained disciplined in pursuing growth through the strategic initiatives my Foolish colleague Tim Green referred to above, and first-quarter results suggest that is bearing fruit. Still, even though revenues attributable to new initiatives rose 30% in the quarter to March 31, consolidated revenues fell 12% (the exchange rate accounted for eight percentage points, with divestments of businesses responsible for the rest of the decline). Wall Street is not known for its patience, and IBM's revenues last year were roughly unchanged relative to 2006.
Right now, the challenge for IBM is to continue on its path, resisting projects that could provide a short-term boost to revenues at the expense of profitability. Thankfully, IBM has at least one very big supporter with a very long-term horizon.
At the beginning of March, Berkshire Hathaway (NYSE: BRK-B) CEO Warren Buffett told CNBC:
It's a company that has been doing exactly what I like ever since we started buying it [...] There have been no surprises at IBM since we started buying it a few years ago. We expected revenue to come down. We expected a year like this where foreign exchange would take a whack off revenues.
Berkshire Hathaway is IBM's largest shareholder.
Alex Dumortier, CFA, has no position in any stocks mentioned. Tim Green owns shares of International Business Machines. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway and International Business Machines. Try any of our Foolish newsletter services free for 30 days.