How much trouble is International Business Machines Corp. (NYSE: IBM) in? We recently talked to tech blogger and IBM book author Robert X. Cringely - and he sees a troubled road ahead.
Last summer, Cringely released The Decline and Fall of IBM: End of an American Icon? In it he explores the missteps that caused this once-feared, 100-year-old technology company to lose its edge in a rapidly growing tech landscape. Cringely has been following IBM's decline since 2007.
IBM's troubles began in 2003. That's when then-CEO Lou Gerstner - credited with reinvigorating a struggling IBM in the 1990s by transforming it from primarily a hardware company to a business services company - handed the reins over to Sam Palmisano.
Cringley wrote that under Palmisano, IBM sacrificed the quality of its enterprise tech services at the altar of misguided shareholder-friendly policies.
It began with the so-called "road maps." In 2005, Palmisano's road map promised a 2010 earnings-per-share (EPS) goal of $10. IBM beat it. In 2010, he promised $20 EPS. That goal proved fruitless and, Cringely argues, it had a hand in IBM's current decline...
Through cost-cutting measures that included slashing jobs, offshoring services, and buying back shares with borrowed money, Palmisano helped bring on the deterioration of IBM, Cringely wrote. And that is being felt now by the new CEO, Virginia "Ginni" Rometty.
Rometty is faced with turning around a giant in the era of cloud computing and Big Data. She's identified cloud, analytics, mobile, security, and social (CAMSS) as the important growth initiatives for IBM. But has she been handed a company too badly beaten up to transform? Can she turn a ship around and abandon the destructive shareholder-friendly policies?
I spoke with Cringely to get his take. Here's what he had to say.
Money Morning: The last two years have been very humbling for IBM, as the IBM stock price has fallen 22%. The company abandoned a longstanding EPS pledge of $20 in October. They sold off businesses, most notably, their low-end server business to Lenovo Group Ltd. What was the most telling moment for IBM this past year, and what would you say is their biggest misstep?
Robert X. Cringely: I think the most telling thing was the abandonment of the earnings-per-share goal - the 2015 goal of $20 earnings-per-share. Frankly, [Rometty] should have done it the day after she took over from Palmisano. With his target, he said it; she had an option when she was appointed CEO - you get a mandate - and she got a mandate from the board to make some changes and she could have said, "Sam's a nice guy but he was a little over ambitious, I don't think we're going to make $20." She could have done that. But she didn't. She drank the Kool-Aid and she kept the $20 goal, which they weren't on a trajectory to do even then, and so I think that was a horrible misstep and repudiating it was a good thing and an inevitable thing.
However, the big error that they made... was selling the low-end server business, which makes little sense and sort of destroys some of their numbers in the act.
MM: It sounds like IBM sold the low-end server business because they weren't making money for the company - is that the case?
RC: They could have [made money from it]. They could have outsourced manufacturing. They could have done what Lenovo will do with it. Lenovo will make it a very profitable business. The important thing about the low-end server business is that it is the future of the server business. So to say, "Well, we're not making enough margins on this thing that happens to be the future, so we're just going to blow it off, get rid of it" - that's senseless. The better thing is to say, "How can we adapt to fit better with the future?" They make sounds about it with their current strategy, but they had it with that.
It's really important to look at what happened with that sale and its implications for IBM. First of all, they're not in the low-end server business anymore.
However, their claim that the cloud business brought them $27 billion in the last year is dependent in large part on the sale of those servers. So they've booked in that $27 billion, both the sales from that server line and the proceeds from selling it! And they rolled that all into their cloud claim.
So yes, they had this huge increase in cloud revenue and it looks great, except those hardware sales that were associated with it won't be there next year. Their cloud revenue increases, even under this, frankly, distorted way of doing it, are lower than their competitors. And they will be, next year, lower still because they don't have these tricks that they can play. They're taking advantage of it while they can. Next year, cloud is going to be a disaster for IBM.
MM: Your book discussed in detail the problems facing IBM's Global Services Business, its largest revenue-generating segment (about 60% in 2014). Namely, that cuts to this business have been the cause of a much bigger decline. How will this affect their move into the CAMSS businesses?
RC: It's tough to roll out technology initiatives that you can't support. And that's a big problem. They have this idea that they have a technology that they gain "X" billion dollars in revenue from, but they bring in support services that generate 3x to 4x on top of that. And that's the business. However, if you're not doing a good job of the service side, which they're not, they're not treating customers right, and nobody that I know of is happy with IBM, so that business is in big trouble and they've just viewed it as something they can abuse to cut costs and align the business the way they say they're going to do. But this just doesn't make any sense. This is part of my great confusion about what's really going on there. How can you just take horrible advantage of your customers at a time when you need them the most? I don't understand it.
MM: IBM has certainly had to go through transitions in the last 100 years, and some of the tech analysts say this is a company with the type of executive team that can make this type of transition. Do you think Rometty and her team are capable of turning IBM around?
RC: This is a company where the people in it have, for the most part, never worked anywhere else. That's why they've had a unique discipline over 100 years, that's also why they have a unique worldview that sometimes gets out of sync with the rest of the world. And right now that's the case. They're trained to handle a transition. They can describe it. They can make PowerPoint presentations about it. They can predict large expenditures related to it. But, executing it is tough, especially in an incredibly dynamic market or five incredibly dynamic markets, as they're proposing. While in the process, they're pretty much ignoring what's really making the money.
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MM: At this point, does IBM have any hope?
RC: Yeah, I think that they do. They have a heck of a mainframe business that they could throw a little bit of money in and help it a lot.
One of the problems with IBM is that their customer base has always been the Fortune 100. And that isn't growing. If anything, that market is shrinking. So, they have to go down-market in order to have revenue growth. And they look at that abhorrently because down-market means lower margins. At the same time, what we see is an increasingly sophisticated market where the sorts of things that matter to the Fortune 100 companies now matter to all companies. And there are ways to take those technologies and apply them efficiently and profitably in the middle-market that IBM just isn't doing because they don't see it as having potential. So they try to think, "How can we suck more money out of a large government contracts and large corporate contracts?" And there's a limit to that. Their downsizing the company isn't in acceptance of that. They're downsizing in terms of outstanding shares. They're downsizing in terms of the total size of the company - headcount, revenue, profit.
If I were to guess, I would say Ginni Rometty is imagining a profitable $80 billion company. That's what she's seeing. If four years from now, which is the logical threshold to look for, I'd say her hope is to be a profitable $80 billion company. And she'll get her outstanding shares down to about the 800 million range to support that. If there's a grand plan, I bet that's it.
MM: So what's the bottom line on the future of IBM?
RC: I certainly don't think IBM is going to go out of business. But I think that they'll probably never see IBM with $100 billion revenue after this year. And the company will have to either revitalize its services business, or sell it. That's the dark horse, maybe they can do that. I don't know.
Elsewhere in Tech Investing... There are some whispers that Google Inc. (Nasdaq: GOOG, GOOGL) is going to buy Twitter Inc. (NYSE: TWTR). It sounds like a great move. After all, Twitter needs user growth and Google has the vast platform to drive more people to the service. And Google needs a presence in social, one that Twitter can provide. So, is Google going to buy Twitter?
