3 Ways IBM Could Become Great Once Again

By Technology Fool.com

Despite boasting famed billionaire investor Warren Buffett as a major shareholder, IBM has been unable to pick itself up out of the doldrums.

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Case in point: Despite dozens of acquisitions over the past six years, as well as laudable cost-cutting initiatives, both revenues and profits have continued to slide downward, particularly in the past two years. While the picture isn't all bad -- IBM's shares continue to benefit from healthy dividend payouts and share repurchases -- something clearly needs to be done. This is not the same company that created Deep Blue and engendered mass adoption of the personal computer.

To compete in the 21st century, IBM will need to get ahead of the curve and innovate. Today, three of The Motley Fool's contributors explain just how they think Big Blue can start competing again.

Tim Green (be the best): It's no secret that IBM was slow to embrace the cloud, but that doesn't mean the company is doomed. Amazon.com (NASDAQ: AMZN) tends to get most of the attention when it comes to cloud computing, with AWS being the dominant provider of infrastructure-as-a-service. But in the long run, IBM's focus on the high-value portions of the cloud computing market gives the company a much better chance of gaining a meaningful competitive advantage.

Consulting is one of those areas, and IBM's recent $200 million acquisition of Bluewolf Group, as reported by Re/code, offers a window into the company's strategy. Bluewolf is a consulting company that helps businesses use Salesforce products, as well as other cloud software. IBM competes with Salesforce, as well as many other cloud software companies, but being brand agnostic is critical for IBM to succeed. Back in the '90s, when former CEO Lou Gerstner was reinventing IBM as a services company, brand agnosticism was a key component, and that remains true today.

Cloud computing has brought with it new options and lower costs for businesses, but it hasn't really made the IT landscape any simpler. By focusing on helping organizations transition to the cloud, and by providing other high-value services, IBM can carve out a very profitable cloud computing niche. IBM's path to greatness depends not on competing in businesses where scale is the only real way to gain an edge, like infrastructure-as-a-service, but on providing exceptional value to its clients.

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(strategic imperatives): As part of its business transformation,IBM has invested a mind-boggling $5 billion-plus in the past year to give a boost to its data analytics, cloud, big data, security, cognitive computing, and, to a lesser extent, mobile and social initiatives. Collectively, CEO Ginni Rometty refers to the emphasis on these fast-growing markets as IBM's "strategic initiatives."

The objective is to shift away from PCs, hardware, and other legacy business lines and focus on today's data-intensive needs. In addition to numerous acquisitions IBM has also financed new divisions, including cognitive computing and Watson Health. Therefore, with so much riding on IBM's transition,failure isn't an option. The good news for IBM shareholders, and investors in search of a sound, long-term growth and income alternative, is Rometty and team are beginning to deliver.

In Q3 of 2015, IBM said strategic imperatives made up 27% of revenue -- not bad, considering the relatively early stage of its transition. Now the better news: By year end, strategic imperatives generated $28.9 billion of IBM's $81.7 billion in total sales, accounting for 35% of its 2015 revenue. It was only a few months ago Rometty was targeting 40% of sales from IBM's strategic imperatives by 2018.

After last quarter's performance, it's about time IBM pushed its strategic imperatives goals higher, which should be music to the ears of investors. Based on the last month's 11% share-price pop, a lot of IBM investors apparently like what they hear. When it's all said and done, IBM needs to keep delivering on its strategic imperatives to become great again. So far, so good.

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(emulate Alphabet): OK, so maybe I'm being a littleover-dramatic. But hear me out. IBM has gone through some major structural changes in its long history, arguably the biggest of which, was the shift from hardware design and manufacturing to being a software, IT, and service-focused conglomerate, which began in the early 1990s. This was clearly the move to make, even though it rendered IBM's own moniker -- International BusinessMachines -- irrelevant.

Today, we find an organization once again in transition. Its actual business, despite being in gradual decline, with revenues falling from $97.6 billion in fiscal 2010 to $79.9 billion in fiscal 2015, continues to generate copious amounts of free cash flow. Last year, IBM's cash from operations came to a more than respectable $17 billion, which nets shareholders, after subtracting $3.6 billion in capital expenditures, free cash flow of $13.4 billion. IBM is -- as Warren Buffett would be quick to point out -- making decent use of these funds. Not only does IBM pay out just under $5 billion per year via dividends, but it also repurchased over $4.6 billion worth of stock on the open market in fiscal 2015 alone. However, if IBM wants to succeed in the 21st century, it will need more than just financial engineering.

Take Alphabet for example. Not only does Alphabet have a cash cow in its Google search engine, but it continues to invest in the future. Last year, Alphabet's operations generated $75 billion in revenues, GAAP net income of $16.3 billion, and free cash flow of $16.1 billion. Did Alphabet rest on its laurels, earned by owning the world's No. 1 search engine? No way. It spent a whopping $9.9 billion on capital expenditures, a full 38% of cash from operations, all meant to keep Alphabet on top and create the next big, world-changing business. Granted, IBM is doing its own R&D spending, shelling out 21% of cash from operations on capital expenditures, but to succeed in the world of tomorrow IBM needs to start taking a few more gambles. Otherwise, it risks irrelevance.

I'm not saying IBM should cease all dividend payments and share buybacks in favor of throwing money at speculative ventures. What I am saying is that to compete with the top tech firms of today, IBM needs to up its game and be just a bit more like a tech start-up. One might say Big Blue needs to relearn its innovation ABCs and become a little bit more like Alphabet.

The article 3 Ways IBM Could Become Great Once Again originally appeared on Fool.com.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fools board of directors. Sean O'Reilly has no position in any stocks mentioned. Tim Brugger has no position in any stocks mentioned. Timothy Green owns shares of International Business Machines. The Motley Fool owns shares of and recommends Alphabet (A shares) and Amazon.com. The Motley Fool recommends Salesforce.com. 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.