Why IBM’s results reveal its future challenges
Must-know: Is IBM on the road to recovery or stuck in transition? (Part 6 of 8)
IBM’s future challenges
IBM Corp. (IBM) has reported revenue de-growth both on a yearly and quarterly basis for quite some time. Its faltering hardware business and slow growth in emerging markets is adding to its woes. As a result, it is losing its leadership position to its peers. HP (HPQ) has become a leader in the server market, that was once held by IBM.
Increased adoption of cloud computing is putting pressure on the hardware and server market. IBM’s 1Q14 results show that cloud computing revenues have grown by 50%. However, it’s yet to be seen if they will be able to compensate for the declining revenues. It appears that the cloud space isn’t so easy to break into. Amazon (AMZN) web services, Google (GOOG), and Microsoft (MSFT) dominate the space. In response to the rising competition, Google has slashed its prices on computational and storage services.
The previous chart shows IBM’s net income margins and return on equity (or ROE). The 2014 figures refer to trailing 12 month (or TTM) figures.
High margins and RoE
IBM has always attracted a lot of attention because of its high ROE that implies IBM’s productivity with shareholder’s funds. Despite no or flat revenues, IBM’s margins have seen expansion. This is primarily due to IBM’s transition from low margin to higher margin businesses. Margins are expected to see further expansion as IBM targets revenue from software to contribute to 50% of its profit by 2015.
IBM’s debt levels are increasing, which indicates that through debt, it’s buying back its shares leading to s lower number of shares in circulation. As a result, share buyback reduces the shareholder’s equity. When companies use debt to fund share repurchases, it increases ROE. However, it also exposes shareholders to more risk.
Stock prices in tandem with falling revenues
It’s a common notion that stock prices have a strong correlation with revenue growth rates and earnings. IBM’s falling revenues and increasing earnings per share (or EPS) have given mixed signals to the market. However, the company’s dwindling share price, despite the management’s aim and claim to achieve $20 EPS by 2015, indicates that the market has become wary about IBM’s growth.
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