International Business Machines Corp's Biggest Failure in 2016 So Far

By Markets Fool.com

I recently discussed International Business Machines'(NYSE: IBM) business model and its three best moves in 2016. Those moves included its partnerships with NVIDIA in machine-learning GPUs, Cisco in edge analytics, and Workday in cloud-based HR management.

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Today, I'll focus on IBM's biggest failure of the year -- failing to break its streak of 17 consecutive quarters of year-over-year revenue declines. Let's discuss why IBM's top-line growth is in such bad shape, and how it plans to get its sales back on track.

IBM Studio, London. Image source: IBM.

The infamous $20 promise

IBM's current problems can largely be attributed to former CEO Sam Palmisano's plan to double the company's earnings per share from $10.01 in 2009 to $20 by 2015. That plan sounded impressive and even Warren Buffett, who famously avoids tech stocks, had Berkshire Hathaway take a $10.7 billion stake in IBM.

However, Palmisano's plan was comprised of shedding IBM's lower-margin businesses to protect its bottom line, cutting costs, and repurchasing billions of dollars in stock. This strategy artificially inflated IBM's earnings per share, but prevented the company from making any major purchases in the higher-growth cloud, mobility, and analytics markets.

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As a result, IBM fell behind companies like Amazon (NASDAQ: AMZN), Microsoft (NASDAQ: MSFT), and Alphabet's (NASDAQ: GOOG) (NASDAQ: GOOGL) Google, which emerged as the market leaders in cloud platforms. As a result, demand for IBM's older IT services, software, and hardware -- mostly on-premise solutions -- stalled and caused its revenue growth to dry up. IBM's earnings also never hit Palmisano's $20 target. Its EPS from continuing operations came in at just $14.92 in 2015.

Rometty to the rescue?

Ginni Rometty, a 30-year veteran of the company, replaced Palmisano as CEO in 2012. Rometty finally pivoted IBM away from its unsustainable strategy of inflating earnings.

In 2013, IBM acquired cloud infrastructure giantSoftlayer Technologies for $2 billion in an aggressive bid to catch up to Amazon, Microsoft, and Google. It followed upthat purchase with more big buys in the cloud and analytics space -- including cybersecurity firm Trusteer for $1 billion, mobile device management firm Fiberlink Communications for $330 million, health imaging software maker Merge Healthcare for $1 billion, storage software maker Cleversafe for $1.3 billion, healthcare analytics company Truven Health Analytics for $2.6 billion, and Salesforcesystems integrator Blue Wolf Group for $200 million.

Image source: Getty Images.

Rometty rebranded the five businesses of cloud, analytics, social, mobile, and security as IBM's "strategic imperatives." The ultimate goal was to have these businesses grow fast enough to offset the declines at its legacy businesses. But based on IBM's revenue growth last quarter, those businesses simply aren't growing rapidly enough to boost its top-line growth back to positive territory.

Segment

Q2 Sales

Q2 Sales Growth (YOY)

Strategic Imperatives Growth (within the unit)

Segment Sales From Strategic Imperatives

Cognitive solutions

$4.7 billion

4%

9%

64%

Global business services

$4.3billion

(3%)

13%

53%

Technology services and cloud platforms

$8.9billion

0%

35%

22%

Systems

$2.0billion

(23%)

(14%)

45%

Data source: IBM investor presentation. YOY = year-over-year.

Why aren't these businesses growing fast enough?

IBM's total strategic imperatives revenue rose 12% annually last quarter, and accounted for 38% of its revenue over the past 12 months. Unfortunately, that represents a slowdown from 14% growth in the first quarter and 20% growth in the prior-year quarter. That growth is also pretty weak compared to Amazon's numbers.

Amazon Web Services(AWS) revenue rose 58% annually to $2.89 billion last quarter, and it had an annual run rate of $11.5 billion. IBM's entire cloud-as-a-service business had an annual run rate of just $6.7 billion last quarter. The Bluemix platform, which competes against AWS in the higher-growth cloud platform market, only had an annual run rateof about $600 million as of last October, according to Forrester Research.

Amazon's scale and "best in breed" reputation allow it to serve massive customers like NASA, the CDC, Netflix, and Salesforce with its servers. If they don't go with Amazon, they'll likely consider Microsoft's Azure or Google's Cloud Platform before considering Bluemix. That's why IBM's strategic imperatives growth is slowing down.

How many more quarters of declines are ahead?

IBM's revenue will continue falling as long as its strategic imperatives fail to offset the declines at its older businesses. Analysts expect that trend to continue, withrevenue expected to fall 1.5% this quarter, 1.3% next quarter, and 2.6% for the full year. Unless IBM reverses this trend, we could start tracking its revenue declines in years instead of quarters.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Leo Sun owns shares of AMZN, CSCO, and CRM. The Motley Fool owns shares of and recommends GOOG, GOOGL, AMZN, BRK-B, NFLX, NVDA, CRM, and WDAY. The Motley Fool owns shares of MSFT. The Motley Fool recommends CSCO. 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.