Ahead of the technology giant’s release of fourth-quarter and full-year results, analysts began questioning the quality of the earnings of International Business Machines (NYSE:IBM). After peeling back the layers of the company’s earnings report, it becomes clear that even though IBM management is able to almost systematically beat Wall Street expectations, the company is no longer the reliable earnings machine it once was.
In the six consecutive quarters through the third quarter of 2013, IBM’s revenue has fallen, a drop largely due to weakening demand for its hardware products. “IBM has badly missed not just revenue but profit two of the last three quarters, which is unusual,” UBS analyst Steve Milunovich said in an October research note to clients. “The poor near-term results and question raised about farther out earnings power can’t be ignored.”
Revenue continued to follow the same trend in the fourth quarter of 2013. IBM — the world’s biggest computer-services provider — reported its seventh straight quarterly sales decline on Tuesday amid a large drop in demand for services and hardware products, and revenue missed the expectations of Wall Street analysts, marking the fourth consecutive miss in that category.
IBM’s earnings release showed that revenue declined 5.5 percent to $27.7 billion, below the $28.25 billion projected by analysts. Annual revenue was equally as grim: Coming in at $99.8 billion, sales decreased for the second straight year and failed to surpass $100 billion for the first time since 2010. The dramatic revenue decline forced top executives to give up bonuses this year.
“In view of the company’s overall full-year results, my senior team and I have recommended that we forgo our personal annual incentive payments for 2013,” CEO Ginni Rometty said in a statement.
But IBM managed to beat bottom-line expectations. The company reported quarterly earnings excluding certain items of $6.13 per share, an increase from $5.39 per share reported in the year-ago quarter. Analysts had expected earnings to rise to just $5.99 per share. That the technology company was able to exceed Wall Street forecasts and grow earnings is largely the result of its efforts to cut costs — include job reductions, the sale of low-margin businesses, and lower income-tax provisions.
Even with a 2013 share buyback, investors bid the stock down 2.1 percent in 2013, making it the only stock in the Dow Jones Industrial Average that lost value in the past year. The fourth-quarter results did little to signal a turnaround in profitability was in the works as shares of IBM — which closed at $188.43 on Tuesday — dipped as much as 3.7 percent in after-hours trading.
The strategies employed by IBM were not enough for investors and they are not enough for analysts. “IBM has faced some macro and execution challenges and, in our view, has fewer levers to drive EPS without revenue growth,” Wells Fargo analyst Maynard Um wrote in a research note acquired by Bloomberg.
IBM is under pressure to modernize its aging technology portfolio and thereby offset ever-falling hardware revenues. The evidence of that need to transition is clear from the breakdown of the company’s results by unit. Revenue in IBM’s systems and technology unit, which includes the hardware business, dropped 26 percent in the fourth quarter, representing the ninth consecutive quarterly decline in year-over-year revenues for that unit.
Technology services revenue fell 3.6 percent. Meanwhile, revenue at the software unit grew 2.8 percent and business services grew 0.6 percent.
The company is moving away from small servers because it recognizes that the progression of technology is leaving such hardware behind. Cloud computing is the future; providers of that service will offer computing power, software hosting, and data storage for annual fees. On the hardware side of the server business, a well-established pattern will continue, and corporate data centers will run on a fraction of the servers once needed.
To be a competitor among providers of cloud computing, IBM has both turned to acquisitions and higher capital expenditures. Since Rometty became chief executive two years ago, the company has made several big purchases, buying cloud-computing storage company SoftLayer Technologies in 2013 for approximately $2 billion.
The tech giant also has a plan to invest $1.2 billion in the cloud-services business this year. Watson — the Jeopardy-winning computer with software that enables it to learn from past experience, analyze vast amounts of data, and answer questions — is part of this effort. The company announced a new business division this month based on the supercomputer. IBM will invest more than $1 billion in the business, and through Watson, customers will be able to mine vast amounts of data, which will be run on SoftLayer’s cloud.
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