Reviewing IBM’s 2016 Business Perfromance

International Business Machines (NYSE:IBM) stock outperformed the broader markets in 2016 after a disappointing 2015. During the year, the stock rose by 21.1% while the S&P index grew by 10.8%. The primary reason for this has been the shift in IBM’s focus from legacy technology businesses to cloud-centric solutions that deploy the latest technology for different verticals. While this shift in business focus has resulted in a decline in revenue, the company expects an uptick in profitability in the coming years. In this note, we review IBM’s business in 2016.

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Cognitive Solutions Reports A Year Of Growth As Watson Platform Gains Traction

IBM’s Cognitive Solutions segment includes Solutions Software (roughly two-thirds of the segment business) and Transaction Processing Software (the remaining third). The segment includes many of the company’s strategic areas, including analytics, commerce, and security, as well as several of the new initiatives around Watson, Watson Health, and Watson Internet of Things. During the first nine months of the year, revenues for this division grew by 3.5% to $14.82 billion, driven by double-digit growth in strategic imperative revenues.

The adoption of Watson solutions for analytics and the expansion of Watson capabilities to various industries contributed to the growth in revenues. The company continues to add solutions that not only span traditional IT practices in the healthcare vertical but also offer Watson solutions for latest innovations in Internet of Things (IoT). ^[1] Due to its focus on Watson Solutions, the company posted a decline in Transaction Processing Software revenue as the transition to the Software as a Service (SaaS) model (On Watson Platform) continues. In the future, we expect that the company will continue to post robust revenue growth through the adoption Strategic Imperatives solutions and cloud computing. ^[2]

Despite the improvement in revenues, IBM’s margins for this business declined during the year as the company continues to add functionality and services to its Cognitive Solutions. Going forward, Trefis expects that the revenues and profitability for the division will improve as IBM’s clients adopt Watson’s solution for their requirements.

Technology Services and Cloud Platform Revenues To Report Modest Growth

The Technology Services and Cloud Platform vertical maps onto Trefis’s GTS segment and accounts for about 16.8% of IBM’s stock value, according to our estimates. During the first nine months, continued momentum in the hybrid cloud with growth in Infrastructure Services drove negligible (i.e., 0.1%) growth in revenues to $26.0 billion. Integrated Technology, with improved performance in cloud, security and business resiliency services, grew the most in the year. The company continues to see clients sign large infrastructure outsourcing deals with embedded cloud and mobile initiatives, creating large-scale hybrid IT environments. As a result of these signings, infrastructure outsourcing revenue grew by 1.8% during the first nine months of the year, while cloud implementation resulted in 2.8% decline in technical support services to $5.4 billion. We expect that the company will exit 2016 with $34.5 billion in revenue for this division.

GBS Revenue Slides As Cloud Deployment Gains Traction

The Global Business Services division (GBS) contributes over 16.8% to IBM’s stock value according to Trefis estimates. During the first nine months, GBS reported a 2.3% year on year decline in revenue to $12.6 billion, primarily due to declines in traditional consulting and packaged application implementations, especially from the U.S. that contributes most to GBS revenues. Moreover, the company continues to be impacted by pricing pressure and a reduction in elective projects as IBM’s clients continue to move away from on-premise enterprise application work to new business models focused on the cloud and digital services implementations.

However, double-digit growth in digital front office, which includes business analytics and software-as-a-service, offset the decline in the packaged (on-site perpetual license) implementations to some extent. According to the company, digital practices now make up more than half of GBS revenues. As new verticals become a larger part of GBS, they’ll contribute more to the top line performance going forward. Trefis estimates that the company will report close to $16.6 billion in revenues for the year.

 Revenues And Profitability Across System Division Declines

During the first nine months, revenues for the system Division declined by 22.1% to $5.18 billion and pretax income declined by 66.2% to $354 million. The primary reason for this was the decline in shipments for the Z system servers, which are at the end of a product cycle. During the first nine months, Z system revenues declined by over 40% while Power system revenues declined by 23.5%. Furthermore, a 9% decline in storage hardware due to the ongoing shift in value towards software defined storage resulted in 9.7% decline in revenues. Additionally, the System division was negatively impacted as the transition from Unix based systems to Linux-based system continues.

However, IBM has been shifting its POWER system platform to address Linux. As a result, despite the decline in overall POWER system revenues, Linux-based POWER system revenue grew at a double-digit rate and faster than the market. It now comprises over 15% of IBM’s POWER revenue. Additionally, IBM has re-positioned it as a systems business with the Open Power Consortium. This has led to the adoption of Power system for implementation across hyperscale data centers. With the new launch of POWER midrange solutions in high-end systems for hybrid cloud computing, we expect that revenue for POWER systems will improve in the Q4 2016 and 2017.

At present, we have a $144 Trefis price estimate for IBM, which is about 14% lower than the current market price.

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More Trefis Research   

1. Why Is Watson IoT Platform Important For IBM? [↩]
2. IBM’s Strategic Initiatives, Part 1: How Much Value Can Be Added To IBM’s Revenue And EBITDA To strategic Initiatives? [↩]