IBM 2016 Profit Shows Struggle to Move Past Old Operations

IBM 2016 Profit Shows Struggle to Move Past Old Operations

IBM’s forecast for 2016 profit shows the company continues to struggle as a shift to new technologies hasn’t yet offset a persistent slump in demand for its traditional hardware, software and information technology business.

International Business Machines Corp. is in the midst of a multiyear transition that has weighed on the stock. Chief Executive Officer Ginni Rometty is working to drive growth by focusing on newer operations, including cloud computing and data analytics, trying to counter investor concerns about revenue by emphasizing that the new businesses are higher in value and more profitable. While sales of the new services, bundled together under the heading “strategic imperatives,” increased 16 percent to $28.9 billion in 2015, the company forecast profit this year far below analysts’ projections.

Operating earnings will be at least $13.50 a share in 2016, Chief Financial Officer Martin Schroeter said Tuesday. That’s less than the $15 a share predicted by analysts. Currency fluctuations will affect the operating earnings by more than $1 a share, he said.

It’s a “very conservative outlook,” though “they’ve had difficulty meeting targets in the past,” said Bill Kreher, an analyst at Edward Jones & Co., who rates IBM a buy. “This one seems very achievable, but at the same time, the market seems to be in a wait-and-see mode before giving the company credit.”

IBM 2016 Profit Shows Struggle to Move Past Old Operations

Another particular area of concern: software’s continued weakness. In the fourth quarter, software sales fell 11 percent to $6.8 billion. A surprising drop in third-quarter revenue from transactional software — defined as one-time purchases — was a reason IBM lowered its 2015 forecast in October. The decline in transactional software sales continued in the fourth quarter, which had a larger effect on total software revenue, Schroeter said in a call with analysts.

In April, Schroeter said IBM’s annual profit forecast hinged on the ability of the software division to stop shrinking. The company reported that 2015 software sales declined 9.8 percent to $22.9 billion, and gross margins also shrank.

Software Decline

“Software simply didn’t perform to the degree they thought it would,” Kreher said. That may have been a factor in IBM’s lower-than-anticipated operating earnings target for 2016, he said.

The technology company’s shares dropped as much as 4.8 percent in extended trading after the forecast was released. Earlier, the stock closed at $128.11 in New York, the lowest price in more than five years.

The company also faces more competition and a possible price war in legacy IT services, including enterprise resource planning projects, as businesses increasingly divert technology expenses to cloud applications, according to Bloomberg Intelligence analyst Anurag Rana. IBM has been working to move away from providing price competitive services and is seeking to do more deals that fit better with clients’ move to the cloud, such as digitizing the front office.

Within the services segment — IBM’s biggest — fourth-quarter revenue as reported for Global Technology Services fell 7.1 percent to $8.1 billion, while Global Business Services sales tumbled 9.9 percent to $4.3 billion. The GBS division provides many of the legacy IT services that have seen the largest decline in demand.
Longer Effort

“The results imply that IBM’s transformation from legacy IT to next-generation, higher-value services is likely to take longer than what consensus has expected,” Rana wrote in a note.

Operating earnings in the fourth quarter slumped 17 percent to $4.84 a share while revenue declined for the 15th consecutive quarter to $22.1 billion. Hardware revenue fell 1.4 percent to $2.4 billion.

Investors and analysts have been waiting for the new strategic imperatives operations to help IBM return to sales growth, which some expect to happen this year. The company reported that revenue for cloud as a service gained 46 percent in 2015 to $4.5 billion. But competition in the cloud business from rivals such as Inc. will increase in 2016, and Bloomberg Intelligence reported that rivals are likely to cut prices, adding another roadblock to IBM’s transformation efforts.

Strategic imperatives now make up more than a third of IBM’s $81.7 billion in sales. The company sees these products and services reaching $40 billion in revenue or 40 percent of total sales by 2018.

The company also expects to see more growth in the new services it recently started to provide in cognitive consulting — helping clients implement machine learning and predictive analytics services such as Watson, Schroeter said.

Continued growth in business analytics — what Kreher calls IBM’s “crown jewel” — is also promising, the analyst said.

“I do believe in the long term, the company will turn things around,” Kreher said. The results from this quarter, however, “are testing long-term investors’ patience.”

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