A Tech Giant No More: IBM Is Too Small to Compete in the Cloud Era

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Caught between obligations to shareholders and employees, IBM (NYSE: IBM ) was unable to commit to the $1 billion per quarter needed to compete in cloud early in this decade. It is now paying the price.

While I have been warning investors about IBM for some time , other analysts are starting to get the message on April 17 after the company reported lower profit margins, and disappointing guidance .

A better sell signal may have been IBM's failure to change the Department of Defense's $10 billion cloud request . As is, the DOD plans to award a contract to a single company - which greatly favors, Inc. (NASDAQ: AMZN ) because of the requirements laid out for this single entity.

The reaction of Sam Gordy, IBM's general manager for the federal business, showed me the company knows it won't win the deal, and can no longer compete for the biggest tech contracts.

Tech Giant No More

IBM is often referred to in headlines as a "tech giant" but the reality is it isn't anymore .

Its latest quarter shows revenue of $19.1 billion , and net income of $1.7 billion, $1.81 per share. That's just two thirds of what Microsoft Corporation (NASDAQ: MSFT ) brought in last quarter . Microsoft's market cap of $742 billion is more than five times IBM's $137 billion market cap.

The best reason to buy IBM for years has been its dividend, now yielding 4.03%. But that dividend, $1.50 per share per quarter, is soaking up an ever-greater portion of earnings and will take almost $1.4 billion to service. It means the company only has $12 billion in cash. By contrast Facebook, Inc. (NASDAQ: FB ), the least well-capitalized of the "Cloud Czars," has $40 billion in cash and short-term securities to sustain its investments.

IBM simply lacks the financial firepower to win the DoD contract, because it prioritized shareholders over investment early in this decade. Facebook, Amazon, Microsoft, Apple Inc. (NASDAQ: AAPL ) and Alphabet Inc (NASDAQ: GOOGL ) did make the commitment to investment, and as a result, history passed IBM by.

IBM was not the only company to make this historic mistake. AT&T Inc. (NYSE: T ), Verizon Communications Inc. (NYSE: VZ ), HP Inc (NYSE: HPQ ), and Oracle Corporation (NASDAQ: ORCL ) also prioritized shareholders over investment in cloud. Oracle is now trying to play catch-up, but the others have fallen by the wayside.

Don't Buy the Hype

Instead of investing in cloud data centers, IBM has managed by press release for years, with current CEO Virginia Rometty continuing the policy of her predecessors. IBM hypes blockchain, it hypes Artificial Intelligence, and it hypes its Watson front-end. But it lacks the capital firepower to capitalize.

It's a Moore's Second Law phenomenon. Moore's Law , which stated that computer chips would grow more cost-efficient over time, also implied they would become increasingly costly to produce. Cloud is Moore's Second Law in action. Those companies that bought into cloud when it was hard now prosper because they have the capital base to service the biggest customers.

The Bottom Line for IBM

As a result, those saying "buy the dip" on IBM, calling it a bargain with a price to earnings ratio in the low teens, are missing the point.

IBM is too small to compete in the new cloud world.

Reporters have suggested breaking up IBM for years , and I joined that chorus in December. I even suggested, back in 2015, that IBM buy Red Hat Inc (NYSE: RHT ) and give its CEO, Jim Whitehurst, the job of trying to bring it back.

At that time, Red Hat would have been an easy buy. It was worth $12 billion, and IBM $150 billion. Now Red Hat is worth $28 billion, IBM $134 billion. The old girl can't even afford a red hat.

Dana Blankenhorn is a financial and technology journalist. He is the author of the historical mystery romance The Reluctant Detective Travels in Time , available now at the Amazon Kindle store. Write him at danablankenhorn@gmail.comor follow him on Twitter at @danablankenhorn . As of this writing he owned shares in AMZN, and MSFT.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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