IBM (NYSE:IBM) is often considered a safe and conservative tech stock, but the company has certainly seen better days.
Big Blue recently reported its 12th consecutive quarter of declining revenues. Its stock has fallen 9% over the past 12 months, dramatically underperforming the S&P 500's 12% gain. Nonetheless, the stock is fairly cheap at 11 times forward earnings, and it has a decent forward annual dividend yield of 2.7%. Warren Buffett's Berkshire Hathaway (NYSE:BRK-B), IBM's single largest shareholder, remains bullish on IBM's long-term prospects.
So let's do a basic SWOT (strengths, weakness, opportunities, and threats) analysis of IBM to determine its business prospects.
IBM's core strengths are its five "strategic imperatives" -- its cloud, data analytics, mobile, social, and security businesses. Revenue from those businesses climbed 16% annually last year and accounted for 27% of IBM's top-line.
Last quarter, strategic imperatives revenue rose 30% year-over-year. IBM expects annual revenue from those businesses to hit $40 billion by 2018, which would account for nearly half of its projected annual revenue. To keep that growth on track, IBM will invest $4 billion on those businesses throughout this year.
Within the cloud unit, demand for hybrid cloud installations will likely grow. Hybrid cloud installations combine local and cloud-based services for larger businesses which aren't ready to move all their data to the cloud yet. Research firm Gartner (NYSE:IT) estimates that half of all U.S. companies will use hybrid cloud installations by 2017.
IBM's strategic initiatives are growing at a healthy rate, but its core businesses aren't. Last quarter, revenue at all five of IBM's main business units -- Global Technology Services, Global Business Services, Software, Systems Hardware, and Global Financing -- declined annually, contributing to its companywide 12% top-line decline.
IBM's revenue growth has stalled due to weak client spending, sluggish demand in the software sector, a strong dollar eating up its overseas revenues, and divestments of lower margin businesses. Divesting lower margin businesses like low-end servers and its foundry business improved earnings per share, but it also caused revenue growth to dry up. CEO Ginni Rometty referred to those revenues as "empty calories," but without them, IBM's top-line growth will remain weak.
IBM's dependence on large businesses is also a double-edged sword. Large businesses are heavily dependent on IBM's mainframes, services, and software, but they are all fairly expensive compared to solutions for smaller businesses. This means that fluctuations in client spending, affected by various economic factors, could weigh down IBM's top-line growth.
On the bright side, IBM's investments in strategic imperatives have expanded its business into interesting new areas. Last year, it invested $1 billion to launch a dedicated business unit for Watson, its data-processing AI platform. Rometty believes that the unit can generate $10 billion in annual revenue within a decade.
IBM also invested $1.2 billion in bolstering its cloud-based businesses. New partnerships, like ones with Microsoft (NASDAQ:MSFT) and Apple (NASDAQ:AAPL), could also strengthen that business with co-developed cloud-based middleware and apps.
Earlier this year, IBM established a new Internet of Things (IoT) unit, pledging to invest $3 billion in the business over the next four years. Those investments could give IBM a foothold in the booming IoT market, which IDC expects to grow from $1.9 trillion to $7.1 trillion between 2013 and 2020.
Lastly, IBM is licensing out its designs for semiconductor chips, servers, and software to tech firms in emerging markets like China. Members of that program, known as Open Power, provide base technologies to overseas firms to forge new overseas partnerships.
The greatest threat to IBM's future is competition in the cloud. The fastest growing part of IBM's cloud business, its "cloud as a service" business, had an annual run rate of $3.8 billion last quarter. Total cloud revenues rose 60% to $7.7 billion.
That growth sounds impressive, but competing services are growing just as quickly. Revenue at Amazon's AWS unit, which competes against IBM's "cloud as a service" business, rose 49% annually with an annual run rate of $6 billion last quarter. Microsoft's (NASDAQ:MSFT) commercial cloud revenue rose 106% annually with an annual run rate of $3.8 billion last quarter. Microsoft didn't disclose how much revenue came from the Azure cloud service -- which competes directly against AWS and IBM's cloud services -- but Deutsche Bank estimates that the service generates $500 million to $700 million in annual revenues.
IBM's Watson also faces stiff competition in predictive analytics, which help businesses identify trends and predict customer behavior. Google (NASDAQ:GOOG) (NASDAQ:GOOG) uses its Prediction API, Microsoft has Azure ML (machine learning), and Amazon recently launched Amazon ML. Those services and others could derail IBM's optimistic growth forecasts for its strategic imperatives.
IBM's downside potential is fairly limited, but so is its upside. But if the company's strategic imperatives stay on track, it could evolve into a radically different business with much higher growth by the end of the decade. If that happens, IBM's current price could seem like a bargain.