IBM Drops to Almost 5-Year Low as Profit Forecast Is Cut

Updated on
  • New outlook reflects difficult transition to cloud computing
  • Currency moves crimp quarterly sales by 9 percentage points

IBM Profit Endures Tough Transition to Cloud Computing

IBM’s stock dropped to almost a five-year low after the company cut its profit forecast, underscoring the difficulty of trying to reinvent itself as a powerhouse in cloud computing and data analytics.

The shares tumbled 5.8 percent to $140.64 Tuesday in New York, its lowest closing price since late October 2010.

With a looming global economic slowdown and a strong dollar crimping revenue earned overseas, where International Business Machines Corp. gets the majority of sales, the company on Monday lowered its full-year profit forecast, excluding some items, to $15.25, plus or minus 50 cents. That compares with IBM’s previous outlook of $15.75 to $16.50.

The lowered projection came as IBM posted a 14 percent decline in third-quarter revenue to $19.3 billion, short of an average estimate by analysts for $19.6 billion, according to data compiled by Bloomberg. It was the 14th straight quarter of shrinking sales.

Chief Executive Officer Ginni Rometty is experiencing what other technology executives have seen -- a short-term decline in sales -- as they shed legacy businesses to focus on new products that promise more regular subscription-based revenue, as seen with Adobe Systems Inc.’s three-year transition to the cloud. The difference is that IBM is much bigger, with almost 380,000 employees and an existing business that still needs care and attention.

Sales Transition

“Just at the end of the quarter, we did see an elongated sales cycle for a number of our transaction businesses, including software,” which are one-time purchases and not recurring revenue, Martin Schroeter, IBM’s chief financial officer, said in an interview. “Most importantly, we see the results of our investments in our strategic imperative growth, and we want to keep those investments going -- we do not want to slow down. That has an impact on earnings.”

Translation: IBM is still dependent on big software deals, which take time to secure, while it still needs to invest in new businesses that show promising early results. IBM’s goal is for the new businesses to deliver $40 billion in revenue and account for 40 percent of total sales by 2018. 

“IBM is still on track for the most part -- and over the next three to four years, the strategic imperatives will eclipse the legacy businesses,” said Bill Kreher, an analyst at Edward Jones & Co., referring to IBM’s new businesses. “It did slow from the previous quarter -- that’s something you want to continue to monitor to gauge the success of this transformation.”

Profit in the third quarter, excluding amortization, acquisition-related charges and divested businesses, was $3.34 a share, compared with the $3.30 average estimate from analysts. The stronger U.S. dollar reduced sales by 9 percentage points, the Armonk, New York-based company said in a statement.

Dividend Stock

In the three months that ended in September, IBM returned cash to shareholders by paying out $1.3 billion in dividends and repurchasing $1.5 billion in stock. The company generated $2.6 billion of free cash flow. IBM also reduced its forecast for full-year free cash flow to be relatively flat, from a modest increase.

“This has been more of a dividend stock for us than anything else,” Dan Morgan, a senior portfolio manager at Synovus Securities Inc., said before the results. Depending on dividends and share buybacks “is not a sustainable plan anymore for IBM. They have to show some ability to transform to greater products.”

New Business

IBM said that its strategic imperatives -- cloud, analytics, engagement -- have grown 20 percent year-to-date. The group brought in $25 billion in revenue in 2014. The company has made a bet that the Watson data-analytics unit will help to drive growth. The division, which sells what IBM has called cognitive computing tools, has yet to reach $1 billion in revenue.

“Everyone’s going to be all eyes on how Watson is doing, how their cloud initiative is doing,” Morgan said. “Unfortunately for IBM, that initiative isn’t big enough to get too excited about because they’ve got so many other moving parts.” His company, which has $10.6 billion assets under management as of end of the third quarter, holds IBM stock.

Within the services division -- IBM’s biggest -- revenue as reported for Global Technology Services fell 10 percent to $7.94 billion, while Global Business Services sales dropped 13 percent to $4.21 billion. The slump in GBS sales, due to a slower-than-anticipated transformation toward the strategic imperatives, also helped account for the reduction in the full-year forecast, Schroeter said. Part of that shift includes building out a recently created consulting unit that focuses on cognitive consulting, he said on a conference call.

Revenue in the hardware division fell 39 percent to $1.49 billion. Software sales as reported decreased 10 percent to $5.14 billion.

“It really is on us to keep driving that transformation,” Schroeter said, adding that the shift “takes a little while.”

(Updates with closing share price in second paragraph.)
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