IBM's (NYSE:IBM) Q4 profits came in higher than expected, but not high enough to kick out of the downward spin the company's been stuck in.
In this video segment, Chris Hill, Anthony Arsta, and David Kretzmann look at why this is happening, discuss what the company has been doing to try to end the trend, and how it might be able to succeed in an environment of cutthroat competition.
A full transcript follows the video.
This podcast was recorded on Jan. 20, 2016.
Chris Hill: Let's move over to Big Blue. IBM's fourth-quarter profits and revenue both came in higher than expected, but, I'm assuming, Tony, that expectations are consistently lower for IBM these days, since this was the 15th quarter in a row that their revenue has fallen. That is a staggering number.
Tony Arsta: That's a lot of quarters, yes. To be fair, though, their revenue would have only fallen 2% if it wasn't for currency, rather than the 9% it did fall. So, two-thirds of their business being outside the U.S. has really been a drag on the business. What they've been doing over the last few years, though, is getting out of their traditional things like hardware and a lot of the core businesses they'd been doing in the past, and instead focusing on growth markets like analytics, cloud security.
And those are all growing, maybe a little bit slower than people would like, and again, with currency effects, it only grew about 10% in the quarter. It would have been about 15%, I believe, without the currency headwinds. So, that's growing. And the question is, can that grow and take up the slack from the legacy businesses that they're getting out of. The company is trading at about 11 times free cash flow. It bought back $4.6 billion of stock last year. Dividend yield is over 4%. So it's a reasonably priced, stable company that's trying to grow into growth markets.
The bigger issue is that those growth markets they're trying to grow into, there's a lot of competition. When you look at cloud services, they're competing directly with Amazon. You look at analytics, they're competing with Splunk, which Rule Breakers, I know, has recommended. And then, in the security business, there's companies like Palo Alto Networks, FireEye. Everywhere they're trying to grow, there's a lot of competition that's more nimble and only focused on that one thing. If you want to invest in future technology, it's maybe a more stable play than some of these more niche growth-oriented companies, but there's a lot of competition there.
Hill: We'll get to FireEye in a second. But is this a company, when you think about IBM's history and how it's gone through, at various points, decade-long stretches of out-performance for the stock, and certainly, as we've seen today, it's hitting a five-year low. Is this one of those behemoths that should consider spinning off part of their business? Should they be looking at their cloud business and saying, "You know what? This is going to do better if we spin this off."
Arsta: Well, they've already spun off everything that isn't a new technology area. They've spun off their foundries, they've spun off their server businesses--
Hill: They still have Watson, right?
Arsta: They still have Watson, yeah.
David Kretzmann: [laughs] That's important.
Arsta: When they spun off the foundries, they paid a company called GlobalFoundries to take that off their hands. So, they have been divesting of things that are not new growth areas. But they have things like Watson, their cloud business is growing nicely.
There's a lot of competition, though. [Amazon.com's] strategy with Amazon Web Services is basically to charge as little as possible to capture a large share of the market and use that to provide other services. If your only business is something that another company is choosing to cut prices on, that can be a tough place to be. But IBM has reinvented itself many times in the past. They are investing in the right areas. It's just a question of if they can outpace all the small up-and-coming threats that they face.
Hill: Let me go back to one thing, I want to make sure I understood what you said correctly. Did you say that when they were looking to sell off their foundry business, they didn't sell it so much as they paid someone to take it off their hands?
Arsta: Yeah ... depending on how you read the press release and what happened, they shelled over some cash for GlobalFoundries to --
Hill: It's like when a baseball team has some high price slugger, they're like, "Yeah, I'll tell you what, we're going to trade you, but we're going to still pay you the majority of your salary."
Arsta: I believe it raised the value of the company in the long run. But yes, they did give up a little bit to get that off their hands.
Chris Hill owns shares of Amazon.com. Tony Arsta has no position in any stocks mentioned. David Kretzmann owns shares of Amazon.com and FireEye. The Motley Fool owns shares of and recommends Amazon.com, FireEye, and Splunk. The Motley Fool recommends Palo Alto Networks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.