IBM's Hardware Woes Create a Buying Opportunity
IBM recently reported a decline in revenue for the seventh straight quarter, with hardware sales continuing to plunge. Emerging markets were particularly weak, with revenue in the BRIC countries falling by 14% over the prior-year period. Earnings per share did beat expectations, but a large decrease in the effective tax rate, along with massive buybacks, were the main drivers. The picture doesn't look pretty, but the long-term story is still intact.
A look at the results
All numbers in this section are adjusted for currency. Revenue for the quarter fell by 3% over the prior-year period, driven down by a 25% decline in the systems-and-technology segment. Software revenue rose by 4%, while services revenue rose by 1%. The services backlog grew to $143 billion, up 5%. Non-GAAP EPS was $6.13, up 14%.
While the hardware business contracted severely, the rest of IBM's business looks fine. Software and services aren't growing all that fast overall, but certain pieces are showing a lot of promise. For the full year, revenue from business analytics grew by 9% to $15.7 billion, or a little less than 16% of total revenue. IBM's recent $1 billion investment in Watson, the Jeopardy-winning computer system, is aimed at growing this division even further, with the company looking to turn Watson into a $10 billion business over the next decade.
Cloud revenue grew 69% in 2013 to $4.4 billion, buoyed by IBM's acquisition of cloud-infrastructure company SoftLayer. The annual run rate for services delivered over the cloud in the fourth quarter was more than $2 billion, and this number should rise as IBM expands its cloud services this year.
An effective tax rate of just 11.2% for the quarter, compared to 25.5% in the same period last year, was the main reason why IBM was able to beat EPS estimates. This is concerning, but IBM also reiterated its goal of reaching at least $20 per share in adjusted EPS by the end of 2015. This growth will be driven by software and services, and with the hardware division now losing money, any improvements in that division will make hitting the target easier.
A few days ago, IBM announced that it is selling its low-end server business to Lenovo for $2.3 billion. Once this deal goes through, the hardware division should look a lot better in terms of profitability. IBM has no advantages in the low-end, x86-based server business, so the sale allows IBM to continue its strategy of exiting low-margin businesses.
IBM's future in the cloud
The long-term story for IBM is one based on software and services, not hardware, so the recent revenue mishaps involving the hardware business are, for the most part, irrelevant. IBM is rapidly working to deliver more services over the cloud, spending $2 billion on SoftLayer and recently announcing a $1.2 billion investment that will build 15 new data centers by the end of this year. With more enterprise customers eschewing dedicated servers, instead opting for delivery over the cloud, IBM is spending money where it needs to.
Server hardware has increasingly become a commodity, and IBM doesn't achieve its industry-leading margins by selling commodities. The company is in a transition, and it's hard to say when revenue growth will resume, but there's no reason to believe that the core software-and-services business is in any real trouble.
The bottom line
IBM's revenue declines, which are solely the result of a weak hardware business, don't matter very much in the long term. With IBM's sale of its low-end server business, the company is quickly moving away from low-margin, commodity businesses. If you ignore the hardware business, IBM's results look fine, and trading at just 11.2 times the full-year adjusted EPS, IBM's revenue woes present a buying opportunity for long-term investors.
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The article IBM's Hardware Woes Create a Buying Opportunity originally appeared on Fool.com.Timothy Green has no position in any stocks mentioned. The Motley Fool owns shares of 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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