) is going to cost Berkshire Hathaway [(BRK.A) (BRK.B)] a lot more
than the $1.3 billion of paper profit that has vanished since last
Friday. With a cost basis near $170 per share, it's unlikely Warren
Buffett can sell 68 million shares of IBM without driving the price
below $170, but that's what he should do: Sell IBM.
The problem for IBM: Its operating model is built around selling
on-premise computing - including so-called "private clouds" - but
the $3.6 trillion IT industry is moving at an accelerating pace in
an entirely different direction, to the public cloud, which is a
low-margin utility model.
As Adrian Cockcroft, CTO of Netflix (
) said, "there is
zero revenue for traditional IT
" in the public cloud. Users pay low variable expense (prices have
been dropping from cheap to super-cheap) with no capex. Question:
How can IBM compete with cheap "rented" computing power? Answer: It
The public cloud is not an environment in which IBM can generate
much profit because, as Salesforce.com (
CEO Marc Benioff said
, "IBM needs to sell a box, and the cloud is not a box." IBM can't
tell its customers to tap into a computing utility (the public
cloud) on a pay-as-you-go basis. It needs customers to continue to
buy expensive packages of hardware, services and software in order
to support its high-margin operating model.
IBM has ceded the low-margin public cloud market to others, and
has focused on the private cloud market. It's a strategy doomed to
fail, and here's why: When you construct a private cloud, you give
up everything that is wonderful and beautiful about the public
cloud. Trading capex for low variable expense doesn't happen when
you have a private cloud. You still have huge capital outlays when
you build on premise. And there's waste involved in building a
private cloud. Instead of paying only for what you use, private
clouds are built for overcapacity (capacity is typically built to
handle 15% above peak usage).
For a tiny fraction of the cost of a private cloud, users can
tap into the public cloud by connecting to a cloud service host. In
cloud is like comparing travel on a horse & buggy to a Ferrari.
You're either tapping into limited on-premise computing power
(whatever your capex budget can afford) or into the vast power of a
centralized, shared infrastructure. Computing projects that used to
take weeks are now completed in an hour or two on the public cloud,
and at a
fraction of the cost
IBM's long-term prospects are troublesome
The move to the public cloud is already entrenched among smaller
companies, and upmarket migration appears to be gaining traction.
As venture capitalists will tell you, entrepreneurs and startups
are all building their IT infrastructure in the public cloud.
(There may be an exception, but I couldn't find one, even in
companies with over $100 million in funding.) This suggests IBM's
long-term prospects are particularly troublesome, as it will have
to wean tomorrow's enterprise customers off of a low-expense
utility model and onto the high-capex private cloud model.
People in the industry tell me at least half of Fortune 1000
companies are already experimenting with the public cloud. Further,
most government agencies are looking hard at the public cloud as a
way to save money. Companies and government agencies are generally
testing new workloads at this point (as opposed to migrating
existing operations), but others are moving much faster.
Samsung recently moved one of its computing hubs to the public
cloud, saving $34 million in the process, and Netflix has moved
everything (their entire IT infrastructure) to the public cloud.
That's a big deal for the likes of traditional IT, since Netflix is
one of the biggest consumers of computing power.
IBM's latest earnings miss is just the beginning
The way I see it, IBM has one hand to play and it's a bad hand.
It can't get behind the public cloud because it's a low-margin
utility. So it's forced to defend the status quo, and ask their
customers to continue constructing capex-heavy on-premise computing
environments. Now that companies have a choice, they are pushing
back on IBM.
That's what I suspect happened during IBM's disastrous first
quarter reported last Friday - and, yes, it was a disaster. But for
a change in the tax rate, the earnings miss would've been 34 cents
instead of 5 cents. In the coming quarters, you're likely to see
similar results from IBM: big earnings misses, declines in revenue,
and a management team in denial.
(By the way, as much as I don't like IBM, Berkshire continues to
be one of my holdings, and is one of my Top Ten picks for 2013. If
you'd like to review my Top Ten list and its performance,
The emergence of the public cloud materially changes IBM's
competitive environment. As such, the stock no longer belongs in
Berkshire's portfolio for a single, simple reason: It's too risky.
Of course, anything is possible, and maybe IBM can make enough
acquisitions to compensate for future losses. But it's not
Buffett's style to speculate on turnarounds. To borrow from
Einstein's characterization of God, Warren E. Buffett does not play
I am long [[BRK.B]] and have no positions in any other stocks
mentioned. I wrote this article myself, and it expresses my own
opinions. I am not receiving compensation for it. I have no
business relationship with any company whose stock is mentioned in
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