How IBM Will Reach Its Profit Potential

How IBM Will Reach Its Profit Potential

International Business Machines is at a crucial turning point. Historically, IBM was known as a computer hardware giant. Over the last few years, the writing on the technology wall became clear, and IBM made the decision to switch focus. This has caused stagnation in its underlying results recently, since a ship the size of IBM doesn't simply turn on a dime. IBM is a $200 billion company by market capitalization after all, and shifting the core of its business strategy will take time.

However, IBM management has pledged to earn $20 per share in core operating profits by 2015. That would represent approximately 23% earnings growth over the company's 2013 operating profits per share, which might seem unlikely given its current revenue declines. Still, management has outlined a series of steps it will take to hit its earnings target. Here's how the company will do it.

Strategy is in the cloud
IBM is determined to shift away from hardware and become much more of a technology consulting business with a particular focus in cloud-based solutions and services. Indeed, there's good reason for this. Technology hardware companies are suffering mightily as mobile devices are simply taking over. Consider that Hewlett-Packard Company saw its revenue fall 6.7% in 2013 and 12% since 2011.

This is due specifically to weakness in technology hardware. Revenue in HP's Personal Systems division fell 3% in each of the past two years, which management attributes specifically to contraction in the personal computer market, amid changing consumer preferences that are increasingly favoring tablets.

The deterioration in the PC industry has afflicted semiconductor Intel as well. Intel posted declining revenue, gross margin, and earnings per share last year. Intel has demonstrated a notable lack of ability to get its chips into tablets, smartphones, and other mobile devices, and the results speak for themselves.

Its Chief Executive Officer Brian Krzanich recently stated in an interview with Fox Business that his company is on track to supply 40 million tablet processors in 2014, which would represent a four-fold increase from the previous year. However, Intel is so late to the party that there's a justifiable skepticism that the strategy will work.

IBM not content to fall behind
IBM is simply not willing to become a member of the technology old school. As a result, its decision to shy away from hardware is the right one for the future. It's rapidly shifting its business, but is still seeing lingering weakness from its hardware segment. This is still a necessary course of action, however, evident by the fact that IBM's revenue fell 5% last year. The revenue decline was due in large part to its Systems and Technology segment, which posted a 26% decline in fourth-quarter sales that led to a $500 million loss for the full year.

By contrast, IBM's non-hardware segments are performing relatively well. Its Software and Services segments each posted increased profit last year. IBM's cloud initiative is also paying off, as the company generated $4.4 billion in cloud revenue last year, up 69% versus the previous year.

IBM is also working hard to increase its market share in the emerging markets. IBM's revenue in the BRIC nations, which represent the emerging nations Brazil, Russia, India, and China, collectively posted a 14% revenue decline in the fourth quarter. In response, IBM's CEO Ginni Rometty recently traveled to China in an attempt to boost her company's standing there.

The road-map to $20 per share
IBM has pledged to generate $20 per share in operating profit by 2015. To do this, IBM is rapidly shifting its business model away from hardware and toward software and services. In addition, the company continues to work toward market penetration in emerging economies across the world. And, IBM will keep buying back several billion dollars' worth of its own shares every year, which will help boost future EPS. These are the steps IBM is taking to reach its profit goals, and it seems likely the company will succeed.

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Bob Ciura owns shares of Intel. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel and International Business Machines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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