International Business Machines Corp. (NYSE:IBM) CEO Ginni Rometty is like a heat-seeking missile, locked on to an earnings target of $20 per share in 2015. The target was concocted in 2010 by then-Chief Executive Sam Palmisano. Palmsiano experienced success with a similar game of “pick a price target and try to hit it,” played between 2007 and 2010, over delivering on an earnings target of $10 per share.
Palmisano’s tenure was defined by a pursuit of innovative business areas with higher margins, such as data mining, analytics, and cloud services. He led the sale of IBM’s personal-computer segment to Lenovo, a move that was controversial at the time but looks increasingly attractive in retrospect as traditional PC makers suffer commoditization, competition from mobile devices, and declining sales.
Palmisano stepped down in 2011 and Rometty took charge in January 2012, inheriting Palmisano’s war for profitability. Unfortunately, the war has had some casualties. Adjusted earnings increased 13 percent in 2012, climbing to $15.25 per share, but grew just 7 percent in 2013, to $16.99 per share. In her pursuit of earnings she has cut costs and cut payrolls — “rebalancing its workforce,” as IBM put it in a statement to Bloomberg.
Earnings growth in 2013 suggested that IBM wasn’t actually on track to hit its target. Not only was the growth too low, but it was also built on a dubious platform. Much of the increase came from onetime tax items and the exclusion of $1 billion in restructuring charges. The company appeared to be trying to hide the fact that declining sales had earnings, fat margins be damned. Ongoing cost cutting and share buybacks also put pressure on the EPS metric, but it’s not clear that IBM should be focused on its diet. Instead, analysts like Soni Sacconaghi from Bernstein Research are focused on the exercise part of the transformation: sales growth.
“With strong cost cutting and significant share buybacks (we expect the company to spend $15B on repurchases in FY14, and to front-load them), many investors expect IBM to hit its $20 EPS target, but remain concerned about the long-term health of the business,” wrote Sacconaghi in a research note earlier in February. “Revenue growth is likely to remain weak through FY14 (at constant currency, we forecast YoY growth of -0.9% in Q1; -3.2% in Q2; -0.2% in Q3 and +1.0% in Q4) and IBM’s guidance suggests that FCF will remain materially below non-GAAP net income (~$16B vs. net income of $18.4B) for the second consecutive year.”