Here's a not-so-bold prediction:
is likely to be the next company in the Dow Jones Industrial
Average to replace its CEO.
Since its board of directors appointed Virginia Rometty to
lead the company on Oct. 26, 2011, IBM has steadily morphed from
a technology leader to a cash cow. Innovation has been replaced
by financial engineering, and the company's just-completed
third-quarter conference call was an exercise in deep frustration
as analysts fumed that Big Blue keeps delivering another set of
It's not Rometty's fault. She inherited a bloated behemoth.
But it's hard to find any solid moves that might pave the way for
a turnaround either.
In the eyes of investors, Rometty got off to a good start. She
immediately tasked her charges with finding every opportunity to
squeeze out profits, which pushed shares above $200 in early 2012
for the first time in company history. That time held another,
more dubious distinction: IBM posted a revenue decline in the
first quarter of 2012 and has yet to show revenue growth
At this point, analysts have moved their ratings to "neutral"
or "hold," with price targets right around the current stock
price. They are just being diplomatic -- because in the absence
of any deep fundamental change, IBM's slide into irrelevance will
This isn't a company that can be fixed by a modest acquisition
or a new piece of hardware. Instead, a breakup of the company
into smaller, more focused segments might be the only answer.
It's just a matter of time before IBM's board realizes that.
For investors, the IBM debacle holds several lessons:
1. Don't focus solely on EPS and
Over the past year, IBM has been talking to investors
about a goal of generating $20 in earnings per share (
) each year, perhaps by 2015. Shares trading for less
than 10 times that goal have simply led investors into a
value trap. In today's market, tech investors are focused
on corporate strategy, industry positioning and, most of
all, revenue growth. Though IBM has been making tentative
forays into cloud computing, virtualization, Big Data
analytics and other hot tech niches, few would consider
the company to be a trend-setter in any niche.
2. Size for its own sake is irrelevant.
IBM's success over the past few years was predicated
on its ability to be a one-stop shop for clients. The
company's many acquisitions over the past decades were
never part of a grand vision -- they were instead made
simply to fill a hole in the product line.
Trouble is, today's IT managers are more squarely
focused on the performance of each piece of hardware and
software they buy, ponying up for best-of-breed
suppliers. That's a lesson that has already been learned
, both of which also pursued a "soup-to-nuts"
3. Service is a commodity.
Companies like IBM,
Computer Sciences (NYSE:
and Electronic Data Systems (now owned by HP) landed
massive service contracts over the past 15 years as
Fortune 500 companies began to outsource all non-core
administrative functions. Yet in recent years, it's
become a race to the bottom, leading these firms to send
jobs to India in hopes of preserving margins. Pricing
pressures continue, so margins in this niche are now
The fact that IBM now has more employees in India than
in the U.S. highlights just
how commoditized the company's core revenue
base has become. (And as a resident of New York's Hudson
Valley, I lament the fact that Big Blue is a shadow of
its former self in terms of white-collar employment.)
4. Don't fool investors.
IBM has increasingly come to rely on financial
gimmickry to produce bottom-line results. For example, in
the the third-quarter, the company posted a
lower-than-expected tax rate to beat the $3.96 EPS
consensus by a few cents. If the company used the tax
rate that analysts were told to use 90 days ago, IBM
would have missed EPS by a considerable amount.
Unfortunately, IBM has become notorious for financial
sleights of hand, and savvy investors should see right
through it. For example, the company's goal of $20 in EPS
comes with a huge caveat. Free cash flow might not be
nearly as robust, and that's the most important metric
that investors should be tracking. In the third quarter,
for example, IBM's cash conversion rate was just 67%,
which means that free cash flow badly trailed net
5. Don't patent, deliver.
The biggest problem with IBM -- and one that has been
around since long before Rometty took the reins
-- is that it has continually frittered away its basis of
innovation. IBM's engineers routinely help the company to
earn more patents than any company on earth. And
management then routinely lets that base of intellectual
) go unused.
Here's an example: IBM was a pioneer in the field of
rapid prototyping, developing machines back in
the 1980s that could convert digital blueprints
into actual three-dimensional products. A young engineer
named Scott Crump realized that IBM had no plans to
commercialize the technology, and bought the IP for
pennies on the dollars IBM had invested.
Today, Crump oversees
, a $4 billion leader in the fast-growing field of rapid
prototyping. There are many other companies that
eventually profited from the great work done by IBM's
engineers. The challenge is for IBM to take the work of
its own engineers more seriously and again become a home
of innovative products -- and not just
So after watching IBM, Dell and HP spit the bit,
should you conclude that investing in large tech
companies is a bad idea? After all, a number of hot
tech IPOs this year are garnering lush
valuations from excited investors. But that's more a
function of the stock market in 2013, and not all of
these young companies will live up to their expectations.
The short answer: You can't simply write off the large
Cisco Systems (Nasdaq:
as an example. The network equipment giant has also
posted anemic revenue growth in recent years, and like
IBM, has been able to generate EPS growth only through
massive share buybacks. But unlike IBM, Cisco
continues to push for industry-leading innovation in all
of its tech niches, and it looks very well-positioned to
boost sales when its core end-markets start to grow. The
distinction in these two companies' technology visions
explains why one company is a bargain and the other is a
Risks to Consider:
As an upside risk, IBM could break itself into smaller,
nimbler divisions, which would quickly be embraced by
Action to Take -->
Though IBM has an increasingly bleak future -- unless it
embarks upon a radical change -- it remains as one of the most
profitable companies (on an absolute basis) on the planet. That
leads investors to the question: "At what price would shares be
attractive?" My view: never. IBM's massive status means the
company (and its stock) will never crash, but it's just too hard
to see any catalysts that would push this stock higher.
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