How IBM Stock Can Stop the Bleeding

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International Business Machines Corp. (NYSE: IBM) stock saw another 1.4% decline in November - its third straight monthly decline.

As of yesterday's close (Tuesday), IBM stock traded at $162.67 for a 13% freefall on the year. That's a standout loss in the Information Technology sector, which is only up 1.6%, in 2014.

The troubles that plague IBM stock are not a mystery. We know what's hampering the company.

But there are signs IBM will break free of this downdraft. We recently looked at how harnessing the potential of "Big Data" will be key to IBM's turnaround. But that's not the only way - there's another major industry that IBM can tap into...

IBM's Struggling Revenue Picture

First, a look at how IBM got to this point...

IBM's harshest critics could have told you a while ago where the company was headed.

In 2007, IBM began a large-scale restructuring plan to eliminate wasteful spending and help the bottom line. This involved layoffs, outsourcing, and divestitures.

Former Chief Executive Officer Sam Palmisano was in charge. In 2010, he had an overly optimistic 2015 projection for IBM's earnings-per-share (EPS) to be $20.

This drive for earnings growth kept the IBM culture of divestiture alive and well when Virginia "Ginni" Rometty took over as CEO in 2012. The $20 EPS figure became her problem.

But after a miniscule 0.3% revenue growth gain in Q1 2012, IBM began a trend of red ink that has persisted. The company now has seen 10 straight quarters of falling revenue.

Despite this, profits still initially saw quarterly year-over-year growth. There was one small loss in Q3 2012 under Rometty, but that was sandwiched between two quarters of around 6% earnings growth.

IBM stock was also doing well. It gained 6% in 2012.

Then came 2013...

In Q1, IBM reported not only a 5% decline in sales, but also a 1% decline in earnings. The day these numbers came out - April 19 - marked IBM stock's worst one-day performance under Rometty. Shares plunged 8.3%.

This was the day markets began to understand IBM's real troubles. IBM's layoffs and divestures were now not even helping the bottom line. The company needed to focus on growth areas.

But nothing changed.

The next earnings release saw revenue down 3.3% and earnings down 17%. Earnings rebounded slightly and grew around 6% for the remainder of 2013 - but revenue continued to fall.

This year was even more painful.

A 21.4% drop in earnings for the first quarter and a 99.6% drop in the third quarter forced Rometty's hand.

On Oct. 20, the CEO tasked with turning the company around was forced to abandon Palmisano's $20 EPS pledge. Shares plunged 7.1% on the day. They have since traded around $160, down from $180 before the announcement.

Now, here's the thing many don't understand...

This announcement and focus redirection is a great sign for IBM stock in 2015...

Where IBM Needs to Focus

Now that Rometty has abandoned the $20 EPS pledge, she can shift her focus. The conversation will now be less about how to hit overly optimistic pledges made five years ago by a former CEO, and more about IBM's true growth drivers.

You see, IBM has had trouble translating its two most promising growth initiatives - Big Data and cloud computing - into top- and bottom-line growth, but is positioning itself well.

Cloud computing is a must for IBM. IBM is going to need to move from its traditional mainframe and data center hardware businesses and focus more energy on the cloud.

But it's clear IBM knows this. There are still a lot of question marks on how exactly this will get done, but there have been positive developments already.

On Monday, IBM inked a deal with the third-largest Swedish bank to help it handle its IT infrastructure. More specifically, cloud IT infrastructure.

The 10-year, multibillion dollar deal with ABN AMRO was just the latest in a $7 billion cloud initiative that began in 2007.

Three years ago, Hunter Muller wrote about IBM and the cloud in his book On Top of the Cloud: How CIOs Leverage New Technologies to Drive Change and Build Value Across the Enterprise.

"IBM is a major participant in the emerging cloud economy," Muller wrote. "IBM's confidence in the ability of the cloud to deliver significant revenue isn't based on wishful thinking - as a cloud user, the company genuinely understands the value and the potential of the cloud as a fundamentally new model for enabling business transformation in rapidly changing markets."

So IBM is out in front. It's just operating in a cloud environment that hasn't matured and reached its full potential.

And that potential is vast. IDC estimates that between 2013 and 2017, public IT cloud services will grow at a compounded annual rate of 23.5%, and by 2017, spending for public IT services is expected to hit $107 billion. It was $47.4 billion in 2013.

Bottom Line: Rometty has her work cut out for her. She's not only tasked with reversing a troubling sales picture through new growth areas, but also changing a culture. The good news: we know where these growth areas are, and so does Rometty. Watch for the next couple quarters. IBM should be making more deals in the cloud similar to the ABN agreement, and this will only fare well for IBM stock.

 

More on IBM: It's not just cloud computing. Growth in this area is a must for an IBM turnaround...