IBM was in the news recently because Warren Buffett sold a third of his stock in the company. Warren Buffett sold off a third of his 81 million shares of IBM stock in the first two quarters of 2017.
IBM has been struggling with the revenue growth problems. We have highlighted that in our previous articles as well. In our article ‘IBM Quarterly Performance Analysis Q1 2016’ written a year ago, we analyzed IBM’s quarterly revenue growth for 20 quarters. Then, we did a detailed analysis of IBM strategic imperatives vs traditional IT business growth as well. Now, we will look at the IBM revenues and net profits from 1996 to 2016.
IBM Revenues from 1996 to 2016
If we take a look at the IBM annual revenues for the past 20 years, we will find that IBM revenues in 2016 were even lower than the IBM revenues in 1998. There has been a continuous decline in the revenues for the past six years and it is expected to continue in 2017 and 2018 as well (as per the Reuters Consensus estimates).
In an interview with CNBC, Buffett said, ”I don't value IBM the same way that I did six years ago when I started buying ... I've revalued it somewhat downward.”
IBM Net Profits from 1996 to 2016
Even though IBM revenue growth has been negative for the past six years, IBM has done well in maintaining its net profit margins by controlling its costs. IBM net profit margins were 14.9% in 2016. IBM has maintained net profit margins in the 13-17% range for the past eight years.
How IBM has been able to maintain its net profit margins?
In the above graphs, you can notice that while IBM revenues have been lower in 2016 than 1998, IBM net profits are nearly double in 2016. IBM revenues in 1998 were $81.7 billion and they were $79.9 billion in 2016. IBM net profits were $11.9 billion in 2016 and they were $6.3 billion in 1998. How is that?
To answer it, we need to take a look at the IBM cost structure. Just like any other business, IBM has cost structure includes cost of revenues, SG&A (Selling, General and Administrative) expenses, RD&E (Research, Development and Engineering) expenses.
IBM SG&A expenses were $16.7 billion in 1998 and they were $21.1 billion in 2016. IBM RD&E expenses were $5.0 billion in 1998 and they were $5.8 billion in 2016. So, SG&A and RD&E expenses have together increased by $5.2 billion from 1998 to 2016. This means the cost of revenues would have decreased much more.
Cost of Revenues decreased from $50.8 billion in 1998 to $41.6 billion in 2016. So, IBM has been able to control its profit margins by controlling its cost of revenues. Earlier, IBM used to have hardware segment costs in cost of revenue. IBM divested some of its hardware businesses. So, that reduced hardware costs. Also, IBM has now more workforce in low-cost global locations than it had in 1998.
What can IBM do to grow its revenues?
It is a difficult question. If Buffett would knew the answer, he would not have sold one-third of his IBM shares. Lets analyze the choices IBM has.
(1) Grow IT services business? It is difficult because of weakening IT demand and increasing competition from Indian IT service providers.
(2) Grow cloud business? They are working hard on that. But, there is tough competition from Amazon, Google, and Microsoft.
In the interview with CNBC, Buffett said, "I think if you look back at what they were projecting and how they thought the business would develop I would say what they've run into is some pretty tough competitors .. IBM is a big strong company, but they've got big strong competitors too."
(3) Grow hardware business? They have already divested lot of hardware business to focus on profit margins. So, they will not get back to hardware business once again.
(4) Grow software business? Again, tough competition from Microsoft, Oracle, SAP, and others.
(5) Get into any other business? We are not sure which one, why and how?
(6) Acquire some other company? IBM keeps doing acquisitions. We are not sure which one would help them now.
(7) Change leadership? We don't want to comment on this.
So, We think it is very difficult for IBM to grow their revenues at high growth rates in future. Even IBM has guided for low single-digit growth in the long term.