Q4 IBM Earnings Say Stock Is Still a "Hold"

Q4 IBM earnings were released today (Wednesday). And unfortunately, this quarterly report suggests IBM stock is as much a "hold" as it was entering the year.

Revenue was down to $24.11 billion. This was a 12% drop from the year before and the 11th straight quarterly drop. Earnings-per-share (EPS) was down to $5.57 from Q4 2013's figure of $5.80. International Business Machines Corp. (NYSE: IBM) bested Wall Street's EPS estimates, but fell short on sales.

While it's troubling that sales fell for the 11th quarter in a row, a deeper look at IBM's financials reinforce where the real trouble lies. And they are much more entrenched than a mixed earnings season.

IBM stock was down 2.2% in after-hours trading to $153.50. It's down 4.3% on the year.

Here's what to keep in mind with today's Q4 IBM earnings...

The Complete Story Behind the Q4 IBM Earnings

IBM unveiled a new mainframe last week. And it was impressive.

The z13, as it's called, is designed to process an extremely high volume of mobile transactions - 2.5 billion a day, or 100 Cyber Mondays.

The IBM mainframe business could use an upgrade. Revenue in IBM's System z segment - its primary mainframe segment - had fallen in four straight quarters. For Q4 2014, it fell 26%. Obviously, the previous product cycle is close to an end.

IBM also sold off its low-end server business to Lenovo last year. These servers provided $4.6 billion in revenue for 2013, but provided no income. That puts more pressure on z systems to fill the void that the departure of x system, which typically provides around 30% of hardware revenue, has left.

But as necessary as the unveiling was, it brought all of IBM's problems to the fore.

Here's why...

IBM wants you to know they're focused on the future.

Through their press releases and shareholder meetings they often highlight mobile, cloud, analytics, and security as their big growth areas.

This was never more evident than at last week's unveiling of the z13. Speakers at the event talked about how the z13 fits in with each of these initiatives. In fact, over almost 3 hours, speakers mentioned the word "mobile" 117 times, "analytics" 67 times, "cloud" 36 times, and "security" 14 times.

These are exciting buzzwords, but what does IBM have to show for it? Cloud revenue was up 60% this past year. Analytics revenue was up 7%. Mobile tripled. Security was up 19%.

But total revenue was down 12%. Like I said, it's been down for 11 straight quarters. For all the promise these four initiatives are supposed to bring to IBM, they're not helping much now. And the stock is touching levels not seen since well before the current Chief Executive Officer Virginia "Ginni" Rometty took over in 2012.

It's been a year since IBM announced it was getting out of the low-end server business. And the strategy going forward is now clear - shed unprofitable segments and refocus on what IBM was always known for, the almighty mainframe.

But that's part of the problem...

What IBM Needs to Do Now

"Little servers are the future of big computing. IBM needs to be a major supplier and a major player in this emerging market," Robert Cringely, technology blogger and one of IBM's harshest critics wrote last year of IBM's high-end server focus. "For a fraction of the cost of an IBM z-Series... the equivalent compute power can be assembled from a modest number of low-cost servers and the new software tools."

There's an argument to be made that mainframes like the z13 still have a place. People in the tech industry have for years predicted the death of the mainframe. But according to Morningstar, they remain popular in the financial services and telecom industries.

The problem is that the mainframe is not a symbol of long-term growth. In fact, the servers IBM sold off had more growth potential in revenue than do mainframes. Low-end server revenue across the market was up 7.4% in Q3 2014, according to researcher Gartner. Mainframes, according to the most recent figures reported by Gartner in Q2 2014, fell by 2.2%

The mainframe is a symbol of something else: IBM's past. Low-end servers failed to generate profits for IBM. So even if they were a growing business, it didn't hurt IBM to offload them. But mainframes certainly aren't the path to the future.

Which is what made the z13's unveiling so unusual. IBM went on about its future in the cloud and in Big Data. At the same time it rolled out the newest version of a product that is emblematic of its past. What was missing was the bridge between the two in the present.

[epom key="ddec3ef33420ef7c9964a4695c349764" redirect="" sourceid="" imported="false"]

And while the present would make for a very boring sales conference, IBM needs to focus on what is driving most of its business now. And that is technology and business services.

Global services, IBM's cash cow - which makes up about 55% of total revenue and 45% of income - has been struggling. Revenue from services has fallen for 11 straight quarters, falling 8% in the most recent quarter.

"IBM needs to fix Global Services, the company's largest division touching the most customers and a catalyst for IBM sales," Cringely wrote. "For IBM to succeed they need a strong and effective services organization. IBM's Cloud strategy, for example, cannot be financially successful without Services. If Services fail, IBM will fail. It is that simple."

That's IBM's most pressing need now. Near the end of last year, Rometty abandoned the pledge of her predecessor, former CEO Sam Palmisano, to deliver $20 EPS in 2015.

This was a good first step, those were the kind of pledges that led IBM down the path of downsizing and divestiture that eroded the quality of its services business. Hopefully, Rometty will take this opportunity to shift focus from overly ambitious, destructive shareholder goals and look toward rebuilding services in this tough interim period.

"If IBM can invest $1.2 billion in the Cloud, why can't it invest $200 million in Global Services?" Cringely wrote in October.

The Bottom Line: To stay relevant, IBM needs growth out of cloud, analytics, security, and mobile. But right now, all the money it pours into these initiatives isn't going to help it through its current problems. This is only the first earnings report since Rometty abandoned the $20 EPS pledge, so we have yet to see if this will have a meaningful impact on services. But this quarterly report showed too much of the same, and makes IBM stock no better than a "hold" at this point.


Are You Sour on IBM? While Big Blue's glory days appear to be over, tech is still very much a booming sector. To get your mind off the struggles of a once-great tech giant, take a look at these 15 up-and-comers in the sector, with our list of 15 top tech IPOs to keep on your radar...