On arriving at IBM, Lou Gerstner famously said in July 1993 that “the last thing IBM needs right now is a vision.” IBM, then reeling after posting what was the highest loss in American corporate history, instead needed “a series of very tough-minded, market-driven, highly effective strategies for each of its businesses – strategies that deliver performance in the marketplace and shareholder value.”
In the 21 years following that announcement, Big Blue has undergone a significant transition from a hardware-focused company to a cloud-oriented software and services provider. Whether this was due to the pursuit of a vision or the execution of strategy is a matter of semantics-the truth is that a willingness to refocus away from historic strengths and instead toward on higher margin software and services has enabled IBM to grow from a $30 billion market cap company when Gerstner started to the eighth largest company by market cap at $237.7 billion according to the 2013 FT 500.
But its transition is far from complete. On January 21, IBM announced it’s fourth-quarter earnings. Though its earnings were up 14%, revenue was down 5%, missing analyst expectations. The numbers were new, but the news was not-this is the third quarter in a row that earnings were up but revenue fell.
In fact, IBM’s inability to generate revenue growth has been an ongoing problem. Over the past ten years, revenue has grown just 3.6%-a CAGR of 0.35%. But thanks to strong cost control, aggressive share buybacks and a targeted transition strategy, IBM has been able to more than double their net income in the same period.
The story of the transition is one of evolutionary, rather than revolutionary change. Under Gerstner and his successors, IBM has taken steps away from their historical hardware focus and instead toward higher-margin initiatives. With Gerstner came a reorientation away from PCs and toward services-cemented by the acquisition of PwC consulting in 2002 shortly after Gerstner’s tenure ended. Sam Palmisano’s stint was marked by a strong concentration on software, with the sale of their PC division to Lenovo and the maturation of its services business. But the last five years in particular have been focused on a pivot toward cloud offerings and services.
Even IBM’s oldest hardware products aren’t immune. The company announced this week’s 50th anniversary celebration of the mainframe that they were launching a System z-based Enterprise Cloud System and aggressive pricing to enable rapid cloud build-outs for clients of all sizes. Other major cloud announcements include Feb. 24th’s commitment that the company would spend $1 billion to put its software portfolio in IBM’s cloud and license it as a service. This follows previous major announcements that the company would spend $1.2 billion to build 15 new data centers and invest another $1 billion in Watson to offer cognitive computing solutions using its Softlayer infrastructure.
With the cloud as the newest stage in its transformation, IBM is taking more risks than before and finding itself going up against market leaders like Amazon Web Services. But as any seasoned investor or executive will tell you, transforming a business-especially one with an enterprise value larger than the GDP of Portugal-takes time and risk. And Wall Street is not known for its patience. Softchoice and Dell recognized this, and last year they were both taken private so that they could complete their transition to higher value services without the constant scrutiny of investors and analysts. With a market cap of almost $200 billion, however, going private is not a viable option for IBM.
Instead, the company has been staving off investors through another method: stock repurchases. In October 2013, IBM’s board of directors authorized an additional $15 billion toward an aggressive stock repurchasing program that, combined with its dividend program, has returned more than $140 billion to stockholders over the past 10 years. The program has been responsible for shrinking the company’s float approximately 1% per quarter, and today IBM has approximately half the number of shares outstanding that it did 20 years ago. The scope of the program is driving the company’s progress toward its often-repeated goal of $20.00 in earnings per share by the year 2015.
But the enormous scope of their buyback program also comes at a significant cost. At $140 billion, it is almost 80% of the company’s total cash from operations over the past 10 years and it dwarfs the amount spent on acquisitions in the same period ($30.1 billion). An important fact, mostly ignored, is that this buyback program has also resulted in IBM’s tangible net worth going negative in 2008 and continuing to decline since.
The company has been good to shareholders all along, but one must question whether a more aggressive approach to acquisitions would have better served the shareholders by positioning the company to be more proactive, rather than reactive, regarding the major market trends of the past 10 years.
We sense that IBM will be much more aggressive on the acquisition front in the coming years. IBM has proven to be great asset managers for the past 20 years. That’s now the minimum expected. The market demands growth to remain an elite stock. We believe IBM is shifting again – this time to be a more aggressive acquirer.
For more from Marty Wolf, see below:
Will Buying Nokia Lead to the Breakup of Microsoft?
What Company Would Buy BlackBerry?
Here’s Why China Isn’t Taking Over the IT World … Yet