Bloomberg News

IBM CEO Faces Wall Street Skeptics as Growth Proves Elusive (2)

May 13, 2014

International Business Machines (IBM:US) Corp. Chief Executive Officer Ginni Rometty will face a skeptical audience when she speaks to Wall Street analysts tomorrow.

As she’s worked to revamp the company in a shifting technology industry, Rometty has kept herself bound to IBM’s target (IBM:US) of at least $18 a share in adjusted earnings this year -- a number that 60 percent of analysts anticipate the company will miss. After eight consecutive quarters of revenue declines, she must start increasing sales or reduce expenses further to avoid missing the profit goals.

At a daylong conference in New York, Rometty, 56, will probably lay out her plan to use newer technology, such as data analytics and cloud computing, to mount a strong comeback in the coming quarters. The question is whether those lines of business can expand quickly enough to make up for falling sales in IBM’s hardware unit and in emerging markets like China.

“There has to be intense pressure on her to carry out the execution of the plan,” Bill Kreher, an analyst at Edward Jones & Co., said in an interview from St. Louis. “The concern is largely about the way to get there.” He advises buying the shares and estimates IBM will hit the $18 target.

Mike Fay, an IBM spokesman, declined to comment.

“We’re transitioning to key growth areas and transforming parts of the business,” Chief Financial Officer Martin Schroeter said on a conference call last month. “We’re continuing to make investments in key growth areas such as mobility, security and cloud, and these initiatives are gaining traction but are not yet at scale.”

Abandon Roadmap?

Those changes need to happen more quickly, and Rometty should consider dropping her earnings targets so she can focus on the transition, said Ben Reitzes, an analyst at Barclays Plc.

“Given the deterioration in earnings quality and revenue challenges, we believe it makes sense for IBM to abandon its roadmap and change its business model,” he said in a research note. The company needs to more aggressively shift to providing technology as a service rather than a product, he said. He has the equivalent of a neutral rating and estimates IBM will report adjusted earnings of $17.80 this year, short of its target.

IBM shares are up 2.5 percent this year, in line with the Standard & Poor’s 500 Index. They fell less than 1 percent to $192.19 at the close today in New York. Eight analysts advise buying the stock, while 24 say to hold and three recommend selling.

After a 30-year career at IBM, Rometty stepped into the role of CEO in 2012 amid sweeping changes in the industry. Her company is still adjusting to the upheaval in the technology world.

Technology customers are increasingly storing data and software on cloud-computing networks, rather than on site, limiting their need for servers and mainframes and the IBM consultants needed to install and maintain them. While the company has shifted its focus to cloud services and data analytics to keep up, the effort has not been enough to reinvigorate sales growth.

Hardware Slump

Lagging demand for IBM’s hardware division continues to drag down revenue, with the unit’s sales falling 23 percent to $2.4 billion in the first quarter. Revenue in developing countries slid 11 percent, or 5 percent when adjusting for currency fluctuations. Revenue from China fell 20 percent.

Tomorrow’s meeting with analysts gives Rometty and her executive team a chance to show how their more recent investments will produce more revenue.

“IBM has implemented significant actions as it shifts toward a higher valued-added mix; by no means is the company standing still,” Jim Kelleher, an analyst at Argus Research in New York, said in a note. “IBM has also shown an ability to align costs in periods of challenging revenue growth.” He has a hold rating on the shares and estimates IBM will fall short of its target with earnings of $17.96 a share this year.

New Products

The company will probably highlight newer products tomorrow like the cloud offerings from SoftLayer Technologies Inc., which it acquired last year, or the Watson cognitive-computing tool, said Toni Sacconaghi, an analyst at Sanford C. Bernstein & Co. In a note to investors, he questioned whether those initiatives are incremental for the company or can actually help boost sales growth. He has the equivalent of a hold rating on the shares and estimates IBM will hit its $18 target.

Cloud Promise

IBM has held up cloud computing as one of its biggest opportunities for growth. Cloud revenue grew more than 50 percent last quarter, and cloud offerings delivered as a service are now on pace to generate about $2.3 billion a year. That’s still a fraction of IBM’s total $100 billion in annual sales.

While it searches for growth, IBM is also cutting expenses and shedding less profitable businesses. Earlier this year, China’s Lenovo Group Ltd. (992) agreed to buy IBM’s low-end server business for $2.3 billion. The deal is awaiting government review before closing, and the companies must convince U.S. officials that the transaction won’t give China back-door access to secrets and infrastructure.

Job Cuts

Lower tax rates have also helped profits continue to grow, and a surge in buybacks has helped IBM hit its targets for earnings per share. It also took an $870 million charge last quarter to cut jobs, and has changed the information it provides in U.S. severance packages in a way that may help reduce age-discrimination lawsuits, according to lawyers and labor law experts. IBM said the changes were made to protect worker privacy.

The company’s cost-cutting moves helped lift adjusted profit to $16.28 a share last year, up 40 percent from 2010.

For this year, the average estimate of 25 analysts is for $17.88 a share in adjusted earnings, less than the company’s $18 target. Next year’s average analyst estimate of $19.79 a share also falls short of a $20 goal.

IBM has said it can meet its forecasts, even as costs mount in its pursuit of the goals. IBM’s debt has climbed, and its cash balance has dropped, partly because of spending on stock repurchases -- spending that could have gone to acquisitions or other investments.

Some Wall Street analysts, such as Morningstar Inc.’s Peter Wahlstrom, argue that Rometty shouldn’t be trying to hit the targets. Yardsticks like revenue and free cash flow are more important than earnings per share anyway, Wahlstrom said. He has a hold rating and estimates IBM’s adjusted earnings will fall short of the target at $17.47 a share this year.

“Those are things that can be kind of managed,” he said of earnings per share. “You don’t really give a company credit for that.”

Numbers to watch include:

*Free cash flow: CFO Schroeter said last month that the company expects at least $16 billion for the year, up from $15 billion in 2013.

“Given that non-operating forces have a limited impact on FCF vs. EPS (buybacks, tax rate, one-time gains, etc), we expect investors to remain focused on this metric and to look for both upside and downside risk at the analyst day,” Bernstein’s Sacconaghi said in a note.

*Acquisitions: IBM said in 2010 it planned to spend $20 billion on acquisitions through 2015. With revenue declining, some analysts say a large acquisition could be warranted.

“Given the ongoing challenges with weak organic revenue (especially in hardware), IBM may need to do a large deal to help stabilize the revenue,” Reitzes of Barclays said in a note.

*Growth markets: IBM has said it expects emerging markets to approach 30 percent of revenue in 2015. Last year, the markets made up 23 percent of total sales after falling 4.9 percent year-over-year.

“We also expect to hear about IBM’s growth markets and what changes have been put in place to stimulate revenue growth,” Reitzes said in a note.

To contact the reporter on this story: Alex Barinka in New York at abarinka2@bloomberg.net

To contact the editors responsible for this story: Sarah Rabil at srabil@bloomberg.net Crayton Harrison


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