IBM is in the process of transformation. IBM is emerging as more than a hardware, software, or services company. IBM is transforming into a cognitive solutions and cloud platform company. In our article, ‘How IBM Makes Money?’, we talked about IBM organization structure changes in 2016 to support this transformation. This organization restructuring was required to arrest the declining revenue growth during the last five years.
In the last quarter, we analyzed IBM’s Q1’16 quarterly revenues and profits in detail. We observed the revenue growth has been negative for 16 consecutive quarters and IBM Q1 revenues were at the lowest levels since 2002.
IBM announced its second quarter 2016 earnings on July 18, 2016. IBM reported $20.2 billion of revenues and $2.5 billion of net income in Q2’16. The quarterly revenues declined by -2.8% year-over-year. So, this was the 17th consecutive quarter with negative revenue growth. While the overall growth continues to be negative, the strategic imperatives are growing in double digits. IBM Chairman, president, and CEO Ginni Rometty said the following on the Q2 results announcement:
“IBM continues to establish itself as the leading cognitive solutions and cloud platform company. In doing so, IBM is pioneering new business opportunities beyond the traditional IT marketplace. In the second quarter we delivered double-digit revenue growth in our strategic imperatives, driven by innovations in areas such as analytics, security, cloud video services and Watson Health, all powered by the IBM Cloud and differentiated by industry. And we continue to invest for growth with recent breakthroughs in quantum computing, Internet of Things and Blockchain solutions for the IBM Cloud.“
In this article, we will go into details of IBM strategic imperatives growth and compare it with the growth of traditional IT business.
IBM Business Segments Revenue Growth
Before we get into strategic imperatives, let us talk about IBM business segments growth. In February 2016, IBM announced a major organization restructuring.
Up until 2015, IBM used to report the revenues for the following business segments:
- Global Technology Services (GTS). Its subsegments included: Outsourcing, Integrated Technology Services, and Maintenance
- Global Business Services (GBS). Its subsegments included: Outsourcing, Consulting and Systems Integration
- Software. Its subsegments included: Middleware (Key branded middleware and other middleware), Operating Systems, and Other
- Systems Hardware.
- Global Financing.
From 2016, IBM reports the revenues for the following business segments:
- Technology Services and Cloud Platforms. Its subsegments include: Infrastructure Services, Technical Support Services, and Integration Software
- Cognitive Solutions. Its subsegments include: Solutions Software and Transaction Processing Software
- Global Business Services. Its subsegments include: Consulting, Global Process Services, and Application Management
- Systems. It includes Systems Hardware and Operating System Software
- Global Financing.
After the reorganization, IBM provided revenues of the new business segments for the last three years (See note 1). So, we can see revenue growth of the new business segments for the last two years. The details of overall revenue growth and individual segments growth during the year 2015 is provided as follows:
- Overall revenues: -11.9%
- Technology Services and Cloud Platforms: -9.6%
- Cognitive Solutions: -9.4%
- Global Business Services: -12.0%
- Systems: -22.3%
- Global Financing: -9.5%
Please note that the revenue growth was flat for few segments when adjusted for currency and divestitures. We are not analyzing numbers in constant currency because sometimes it is favorable and sometimes it is not. We prefer to analyze actual currency growth numbers only. Second, we do not analyze numbers adjusted for divestitures because companies do both acquisitions and divestitures. Companies don’t report how much incremental revenue growth was a result of acquisitions. But, always report how much negative growth was a result of divestitures.
IBM Strategic Imperatives and Traditional IT Business Growth
In 2014, IBM declared its strategic imperatives around big data and analytics, cloud, mobile, social and security. These strategic imperatives are not separate business segments, but they are the areas within the defined business segments. So, their revenue data is not available in detail or on a consistent basis, as the revenue data for the defined business segments.
In 2015, IBM reported $28.9 billion revenue from strategic imperatives. This represents 35% of the total revenues. The revenues from strategic imperatives grew at 17% year-over-year.
If some areas of the company are growing in double digits, while the company is experiencing overall revenue decline, this means that some areas of the business are experiencing much more negative growth.
During 2015, IBM overall revenues had a negative growth of -12% yoy. This implies the IBM traditional IT business had a negative growth of -22% yoy in 2015. Traditional IT business revenues and revenue growth are calculated by subtracting strategic imperatives revenues from the overall revenues.
Why IBM’s traditional IT business revenues are declining so rapidly? There can be several reasons for that.
- Overall market demand may be weakening. In our article on Dow 30 companies revenues and profits analysis, we observed 2015 was the worst year for the profits growth of large enterprises. We believe that the performance of Dow companies is a good indicator of the overall business environment. As per our analysis, the businesses are facing lot of pressure on the profit margins. A pressure on clients profitability weakens demand for enterprise IT products and services.
- Shift of revenues is happening from Traditional IT to cloud. IBM says that GBS revenue continues to be impacted by the shift away from traditional large enterprise application implementations.
- Indian IT services companies such as TCS, Infosys, Wipro are giving competition to IBM when the large deals are coming up on the table for renewals.
- and then, there are currency headwinds and divestitures.
IBM Long Term Outlook
What the IBM future looks like then? IBM is betting on strategic imperatives and continues to make investments in there. It appears that IBM is succeeding in its efforts as well. But, there are several questions remaining to be answered:
- How long the decline of traditional IT business will continue? How much decline in traditional IT business will still happen?
- How long the strategic imperatives business can continue to grow in double digits? What happens to this business once the IT demand weakens further or the competition catches up?
As per IBM Business perspectives presentation in June 2016 (See Note 2), IBM has provided the following outlook for the long-term.
- Low single-digit revenue growth
- Mid single-digit pre-tax income growth
- High single-digit EPS growth with return to shareholders
- Free Cash Flow realization in the 90%’s
We know that Warren Buffett is still invested in IBM. But, some investors are not clear about the payoff when the long-term outlook is for low single-digit revenue growth.