International Business Machines (NYSE:IBM) announced its fourth-quarter earnings on Jan. 19, disappointing investors with weak numbers and lackluster guidance for 2016. The stock dropped the next day, pushing shares of IBM to new lows. Despite the seemingly awful results, investors should always look beyond the numbers. During the company's conference call, CFO Martin Schroeter provided important details that shed additional light on IBM's performance.
Growing the cloud business
One of IBM's strategic imperatives is cloud computing, and the company is going after the market from multiple fronts. In 2015, IBM generated $10.2 billion of cloud revenue, up 57% year over year adjusting for currency, and the annual run rate of cloud delivered as a service reached $5.3 billion. IBM's cloud revenue includes hardware, software, and services, so it's not directly comparable to pure infrastructure-as-a-service providers like Amazon's AWS.
Schroeter talked about the company's progress in the cloud:
To address opportunities we see in this space, in 2015 we made seven cloud acquisitions including Cleversafe for object storage, Gravitant for cloud brokerage services, and Clearleap for cloud video services. We also invested nearly a billion dollars in capital expanding our global cloud data center footprint to 46. We already have an ecosystem of millions of developers globally, and our Bluemix Platform-as-a-Service has already expanded to over a million users, adding 15,000 developers a week.
IBM's acquisition strategy has generally involved buying small companies and integrating their technology. Some of IBM's acquisitions have already been integrated into Bluemix, the company's platform-as-a-service offering, including Cloudant, a database-as-a-service provider that IBM acquired in 2014, and Ustream, a cloud video company that announced its acquisition by IBM in January. Bluemix now has over 1 million users, making it a major force in the PaaS market.
Currency was a problem
The U.S. dollar strengthened against major foreign currencies during 2014 and 2015, and since IBM generates more than half of its revenue outside of the United States, translating sales in foreign currencies into dollars has produced fairly dramatic-looking revenue declines. During 2015, IBM's revenue slumped 12%, but adjusted for both currency and divestitures, revenue declined by just 1%. Schroeter laid out the effects of currency on IBM's results:
Currency affected our reported revenue by over 6 points or $1.5 billion, which is about $350 million more than the spot rates suggested 90 days ago. For the year, currency translation reduced our revenue by over $7 billion. That by itself is the revenue of a Fortune 500 company and currency was also a headwind to our profit performance. We estimate it affected our profit growth by about $300 million in the fourth quarter and over $1 billion for the year.
Over the long run, currency fluctuations shouldn't matter much to investors, as they have little bearing on the performance of the business itself. IBM does expect currency to be a major problem again in 2016, due to both foreign exchange rates and the roll-off of currency hedges, but investors should remember that this is mostly just noise.
Cloud isn't killing the services business
One of the concerns about IBM's vast services business is that cloud computing will lead to smaller deals for IBM, with clients eschewing hardware and opting for cloud infrastructure instead. Schroeter made clear that this hasn't been the case:
We continue to see momentum in our services offerings that modernize our clients IT systems and move their operations into the cloud-based mobile world. We've seen reports that suggest the adoption of cloud IT means shrinking deal sizes, but this is not what we are seeing. Clients are looking to transform their most critical systems into hybrid cloud environments, and the complexity of these partnerships in many cases results in larger engagements.
During the fourth quarter, IBM signed 26 deals worth more than $100 million each, with 70 such deals signed during 2015, up 40% compared to 2014. Seventy percent of these deals involved hybrid cloud content, allowing clients to run workloads both on-premises and in a public cloud.
The rise of cloud computing has been disruptive, but it hasn't really made IT simpler. For large companies transforming their infrastructure, moving to the cloud is far from a trivial task. So while the makeup of IBM's services deals is changing, the business itself doesn't appear to be in trouble.
Mobile partnership is paying off
In July 2014, IBM and Apple announced a partnership that would see IBM develop 100 industry-specific solutions for Apple's mobile devices. The financial terms of the deal weren't disclosed, but the partnership promised to benefit both companies. One of IBM's strategic imperatives is mobile, and the partnership vastly increased its presence in that area, while Apple has been pushing to get iOS devices further into the enterprise. Schroeter announced some good news on the mobile front:
In December we announced that as part of our partnership with Apple, we've now delivered over 100 MobileFirst for iOS applications. This unique partnership brings together the simplicity of design and ease of use of the Apple mobile device, with our ability to build applications that scale securely and efficiently to the enterprise, helping to transform the way work gets done across 14 industries and 65 professions. These apps allow our clients to securely access their most critical data and processes, so that they can redesign workflows and drive productivity. Since we announced the partnership with Apple, we've generated over $1 billion in signings from the program.
IBM's mobile revenue increased by 250% on a constant-currency basis to $3 billion in 2015, with the Apple deal no doubt driving a big portion of that growth. While the legacy portions of IBM are in decline as the company focuses on its strategic imperatives, mobile has been a bright spot.
Power is gaining momentum
IBM's hardware business is now much smaller than it was before it sold off its x86 server business, but the segment performed well in 2015. During the fourth quarter, hardware sales rose 3% adjusting for currency, with a 16% jump in mainframe sales driving much of the increase. But Schroeter explained that IBM's Power server business is also performing well:
Power revenue grew 8%, which is the strongest performance of the year. In Power we are serving a high value market, while adding capabilities and finding new economic models to grow over time. Unix is a declining market, but we continue to address it because it is very a high value space. At the same time, we introduced low-end Linux-based Power systems to capture the growing Linux market, and are building an IP stream through the OpenPOWER ecosystem. Even though the Unix market is declining, by delivering innovation and repositioning the platform, our Power systems have grown four quarters in a row.
IBM founded the OpenPOWER foundation in 2013 in an effort to build an ecosystem around its Power architecture. The effort now has around 150 members, and OpenPOWER products from both IBM and third parties have started to find their way into the market. IBM has stated that its goal is to eventually capture 10%-20% of the hyperscale data center and high-performance computing markets, both of which are dominated by Intel's Xeon processors.
The fourth quarter showed some progress, with the Power business growing revenue by 8% year over year, the fourth quarter in a row of growth. The OpenPOWER effort is still in its early stages, and success is far from guaranteed, but IBM has been making solid progress revitalizing its Power server business.