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July 23, 2015

Big Blue Dollar

IBM continues to be a bellwether assessment on domestic and global capex, though in 2015 almost everyone wishes it wasn’t. To that end, many have started to downgrade Big Blue based on age in the business cycle and, of course, currency. In many ways, the latest quarterly stumble is the mirror image of when all this started. Plotting IBM’s transformation, and the imperative of that transformation, since 2011 is instructive in both economic narrative and the global economy.

It may seem like ancient history now, but in the middle of 2011 IBM could do no wrong. The company had embarked on its new strategic course and was years into it, but there was no urgency at all as the stock was once more the darling of Wall Street. There were then no questions, no thoughts about IBM as a bellwether – it was America being reborn out of the ashes of the Great Recession.
“In the second quarter [2011], our long-term strategic investments in the company’s growth initiatives again helped drive strong revenue performance,” said Samuel Palmisano, IBM chief executive, on Monday. “Hardware, software and services revenue grew at double digits, and we achieved strong profit and free cash flow growth.”
The hardware revenue, in particular, was a bright and shining result even if somewhat askew. The evolution for IBM meant less physical products, including its mainframe origins, in favor of software and services; cloud and all that. But if hardware was going to shine, and they thought it might, the shifting strategy could be much more leisurely and selective.
Mark Loughridge, chief financial officer, said growth was due mostly to upgrades in the regular product-refresh cycle, rather than new sales, but emphasised that the company brought in 68 new mainframe customers who can later be sold other IBM services.  
“Goodness gracious, when you’re up 61 per cent, that’s a pretty powerful quarter in the mainframe business,” he said.
As if to reiterate their pleasure with that hardware growth, Mr. Loughridge emphasized in his prepared remarks for the quarterly earnings announcement what he thought that meant:
Our growth is broad-based from a segment perspective as well. This quarter we had 24 percent growth in hardware, with great performance in all systems brands. These are higher value offerings, not low end content. For example, we have 24 new mainframe customers in growth markets countries just since the introduction of the z enterprise last year. Think of it as planting the flag, which provides a great base for future growth.
Overall revenue at IBM in Q2 2011 was up a robust 12%, certainly indicative of the expansive business climate that was promised as a healthy, sustainable global recovery. Unlike now, nobody much cared about the dollar and currency translations, but it isn’t so shocking four years later to notice that of that 12% growth, 7% of it was due to the then “falling dollar.” That translation differential was widespread, as even in the red hot services segment 12% of the 22% revenue growth was nothing but currency translations.
When the calendar turned to 2012, IBM started missing revenue estimates. It wasn’t at first much of a concern, only an “unexpected” and transitory hurdle to be overcome by the brilliance and great fortune of management’s continued vision.
IBM’s Chief Financial Officer Mark Loughridge promised IBM would deliver revenue growth again in the second half of the year [2012] once it overcomes some obstacles in the second quarter such as currency headwinds and two challenging projects in Japan.  
“I think stabilizing Japan in the second half and seeing the new announcement contribution from our hardware base of business, that’s going to be a significant dynamic,” Loughridge said on a call with analysts, adding that the challenges in Japan were “a bit of an anomaly”.
That was also the dominant view (and has remained so) of every single setback since 2012; “anomalies” to be dismissed as unimportant to the unquestionable recovery unfolding. Whereas currency wasn’t an issue in 2011, suddenly it attained primary mentioning from management, analysts and certainly economists (though they still haven’t figured that one out). From there, it all just progressed in the “wrong” and “unexpected” direction, as leisurely transition away from hardware itself transitioned to the great imperative as if that was the idea all along.
By the middle of 2013, the company was still being universally praised but there were more questions about the company than had been expressed in all of the period immediately following the recession trough.
I.B.M. has met the challenge of economic turmoil and new waves of technology more nimbly than most of its established rivals. It moved quickly to expand in emerging markets, shift to higher-profit products and services, and cut costs.  
But in the first quarter of this year [2013], I.B.M. reported disappointing earnings, below analysts’ forecast for the first time since early 2005.
By early 2014, in reviewing “unexpected” weakness in FY2013, management decided it would suddenly relinquish its bonuses.
“In view of the company’s overall full-year results, my senior team and I have recommended that we forgo our personal annual incentive payments for 2013,” Chief Executive Ginni Rometty said in a statement.
Further, in reviewing the disappointment, hardware abruptly shifted out of future plans in total, as all that mattered going forward was services and the cloud.
“We must acknowledge that while 2013 was an important year of transformation, our performance did not meet our expectations,” Rometty, who is also chairman, said over the weekend in a letter to investors in the company’s annual report. “While we continue to remix to higher value, we must also address those parts of the business that are holding us back.”
By October 2014, three months into the “strong dollar”, IBM shocked Wall Street by abandoning its long-term goal of $20 EPS for 2015. While that was bad enough for what it meant about the transition, in January 2015 management was acknowledging that even those strategic businesses were now underperforming.
Big Blue, facing problems that include slowdowns in software and services, last October abandoned a long-held target of earning at least $20 a share in 2015. On Tuesday, IBM forecast earnings for 2015 of $15.75 to $16.50 per share, below the $16.51 per share average estimate on Wall Street.
The latest quarterly update was the worst so far. Total revenue fell almost 15% (13% without previously divested businesses) which the company expressly blames on the “dollar.” What is not acknowledged is that this is no different than what IBM experienced during the worst of the Great Recession, as the “rising dollar” then was as much of a depressive factor as it is now. Revenue was “only” -4% without currency effects in Q2 2015 which almost perfectly matches its results from Q1 or Q2 2009. On a “constant currency” basis, revenue declined “only” 4% in Q1 2009 and just 7% in Q2 2009.
What was once a relaxed and paced conversion is now nearly life or death.
“IBM’s legacy business is under a lot of pressure,” said A. M. Sacconaghi, an analyst at Bernstein Research. “And at the same time, the company is investing in the new businesses to get them going. So profits suffer.”  
What investors and industry analysts are looking for is solid evidence of a crossover in IBM’s portfolio, when the new fields are rising faster than the old ones are shrinking.  
“We did not see the inflection point this quarter,” Mr. Sacconaghi noted.
Worse, there is yet any positive influence in the near-term.
IBM said it expected third-quarter revenue to be the same as revenue from the first quarter, or about $19.6 billion.  
Revenue from its software business fell 10 percent to $5.8 billion from a year earlier.  
Revenue from global technology services such as outsourcing fell 10 percent, hurt by weak discretionary IT spending by clients.
That last sentence sums up the problem which is far more than hardware vs. services and software. The trajectory of IBM is that of the global economy, which was certain in early 2011 of full recovery, drunken upon the heavy and as-yet unsullied influence of central banks and their deep monetary interventions. But the global economy, and the US economy with it, stumbled in 2012 to which it has never recovered. Economists and analysts ignore it, and so they expect that which the economy cannot deliver and misapprehend the entirety of the related “dollar” movements.
The “dollar’s” trend is indistinguishable from that of either IBM or the economy. What was thought as a sustainable and welcome boost in 2011 was really neither, as the “falling dollar” was just as damaging as its post-June 2014 opposite. Both are forms of instability as the direction only matters in how that is manifested; in terms of the “falling dollar” multi-national companies like IBM are convinced it is most beneficial to everyone, not least of which because it is so visible on the upside in EPS and income statements.
As they are finding out now, it really doesn’t matter much as an unstable economic system is exactly that; eventually it will fall apart with great and “unexpected” damage. You may no longer view IBM as a bellwether about capex and the economy itself, as I do, but it is at least a leading indicator as to what the “dollar” is and is not, related again to economic growth and health. The “falling dollar” may be more fun and reassuring, but it is just as much a mistake and unwelcome presence as it predicts nothing good about the future.
IBM is the 2012 slowdown personified (companies are people, after all) and now, having “achieved” some of the worst results in its history, we get a sense of where the economy is with it. US sales fell 3% in the latest quarter, which wasn’t appreciably better than the -4.7% that IBM suffered in, again, Q1 2009 – currency translations not needed.
Courtesy Jeffrey P. Snider, Alhambra Investment Partners (Author Archive Here)    
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Item Reviewed: Big Blue Dollar Rating: 5 Reviewed By: EconMatters