1 Reason IBM May Fail to Deliver on Cloud Computing Profits

By Markets Fool.com

International Business Machines Corp. suffered another setback on Monday after the tech titan registered its 12th straight quarterly sales decline as investors continue to wait for the company turnaround strategy to bear fruit.

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Shares traded down just 1% the day after the earnings release as the report was not all bad news. Management said adjusted operating profits rose 4%,and currency-neutral revenues in strategic imperatives rose 30%.

As IBM transforms itself from a hardware manufacturer to a 21st century tech-services provider, the company has staked its future on core offerings that it believes will eventually drive sales and profits consistently higher. Those are cloud computing, business analytics, growth markets, and smarter planet, according to its 2011 Road Map to the Future.

Today, both the company and analysts seem to believe that cloud computing is the key component for the future, and in its recent earnings report, management noted as a bright spot that cloud computing was on track to reach $3.8 billion in revenue this year, up from $2.3 billion last year. In February, management also said it would grow revenue from cloud and related future-oriented businesses to $40 billion by 2018,which seems like a big promise, considering those segments delivered less than $25 billion in sales last year.

Because of those years of sales declines, IBM stock is dirt-cheap today, trading at a forward price to earnings of just 10 times. It remains a hugely profitable company with one of the biggest brand names in tech, and it is one of the major players in cloud computing. However, there is a key obstacle to both its leadership in that area and its ability to derive significant profits.

The great disruptor
Amazon may be the direct opposite of IBM. While IBM has seen sales slide for three years and spent its ample profits rewarding shareholders during that time, Amazon has taken the reverse approach. The company has consistently sacrificed profits in favor of growth, ignoring whatever protests may come from Wall Street or investors.

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Amazon founder and CEO Jeff Bezos has made a mantra out of long-term investing and has called out high-priced competitors, famously saying, "Your margin is my opportunity." The company has made low prices a staple of its value proposition to customers, and time and again, the company has shown it is unafraid to sacrifice profits for long-term positioning. It has made waves in every industry it enters, from retail to book publishing to video streaming.

One of Amazon's most promising businesses is cloud computing, or Amazon Web Service. Bezos believes AWS will one day surpass retail to become the biggest division at the company.

Amazon will break out AWS performance for the first time in its earnings report on Thursday, April 23rd. Previously, it reported cloud sales in its "Other" category, of which the bulk is AWS. In 2014, the Other category brought in $5.6 billion, up over 40% for the year, well ahead of IBM.

The two companies are not always direct competitors in the cloud business: IBM tends to specialize in Software as a Service (Saas), while Amazon is better known for Infrastruture (IaaS). However, Amazon has a head start and reputation for low prices that could mean IBM will not be enjoying huge cloud computing profits anytime soon.

Even without Amazon, cloud computing appears to be a low-margin business, as a study of 22 competitors found a free cash flow margin of just 4.5%.Amazon, meanwhile, reported a net loss for the year.

That is a problem for IBM and any investors who are counting on cloud computing to bring the company back to glory. Sales growth in cloud computing will continue, but it will not deliver the profit margins IBM previously enjoyed from traditional service businesses.

The article 1 Reason IBM May Fail to Deliver on Cloud Computing Profits originally appeared on Fool.com.

Jeremy Bowman has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com and International Business Machines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.