A once $200-or-so stock between 2012 and 2013, shares of International Business Machine Corporation (IBM) have been falling towards around $100, the trading range for IBM stock over the entire 2000s. The share slides happened as the company reported declining sales and earnings almost each year during the stock’s retreat after its all-time high in early 2013. The market is naturally shortsighted and thus, never failed to see IBM’s lowered sales and earnings at the time and adjusted its stock valuation downward accordingly.
The market doesn’t really take into account causes of the changes in sales and earnings when pricing stocks. For example, the market doesn’t look at whether IBM’s continued investments in cloud will eventually yield revenue growth and higher profits or produce little in addition and become a cost drag on existing profits. But that’s why sales and earnings are what they are now and how they may continue to change, both of which can be traced back to how IBM has placed and leveraged its cloud strategy.
Need a Coherent Cloud Strategy, But did IBM have One?
IBM is capable of doing a lot of things on so many different fronts, from business software solutions and data analytics to computing technology and IT infrastructure. And so it seems that more than any other company such as Oracle Corp. (ORCL), Salesforce.com Inc. (CRM) or even Microsoft Corp. (MSFT), IBM would need a more integrated and coherent cloud strategy to bring everything along in its move to the cloud. Alternatively, IBM could just sell its software and solutions in the as-a-service format on other specialized cloud providers’ platforms, saving on potentially wasteful, own cloud infrastructure investments.
It’s more complicated for IBM than, say, Amazon.com Inc. (AMZN) when building out cloud services. It was rather straightforward for Amazon to have built AWS, a major cloud infrastructure that powers a significant portion of all internet activities. The entire Amazon business was web-based long before the formation of the cloud as we know. How logical it was for Amazon to use its internet know-how and extend its web services to other companies! Now, an IBM Cloud to compete in cloud infrastructure with Amazon? a cloud provider years before there was any cloud provider. Sounds like a misplaced cloud strategy for IBM.
A company doesn’t have to, and shouldn’t, build a full-fledged cloud infrastructure of its own just to get its products and services on the cloud, when and if its customer base is not wide enough to achieve an optimal use of such cloud investments. It’s something IBM ought to have considered when it set out to the cloud, since the company has a rather unique but somewhat limited client base for the so-called IBM solutions.
Also a software and technology company, Microsoft seems to have successfully built its cloud infrastructure, Azure. The reason Azure is ahead of IBM Cloud is exactly because of the scope of their respective customer base. For one, with a much wider reach by its productivity Office suites, Microsoft is able to use its cloud-based Office 365 to sign up more users. At this point, IBM still lacks a product as universally popular to justify building out an all-out cloud infrastructure, although Watson may become something for everyone in the future.
How IBM Has leveraged its Name-Brand Cloud Platform?
Having spent heavily to build an all-encompassing cloud platform, IBM may have taken its eye off its business software operations, including its transaction processing software, most of which is still on-premise and annuity in nature. It’s eye-popping to think that IBM still hasn’t transitioned this kind of software into an as-a-service model alongside some cloud-based analytics and AI services, specifically designed to further those business software.
Microsoft, on the other hand, has really leveraged its Azure cloud platform to make its old-time productivity suites ever more popular by upping its sales efforts and repackaging them in the cloud. This may have led to more user gains from easier Office access, the kind of investment payoff that should be expected from setting up all the cloud infrastructure.
The IBM Cloud may never reach its full potential if more customers continue to be signing up for AWS and Azure, because of their respective status as a dedicated cloud infrastructure provider and as a cloud provider with an inherent pricing advantage. All AWS does is to provide its users the most reliable and flexible cloud infrastructure, while Azure can give its users more value from their existing Microsoft investments in its widely used Windows operating system and other popular Microsoft products.
The IBM Cloud could conceivably become a new headache for the company when its usage never picked up the speed in the face of strong competition. Seemingly reconsidering its cloud strategy, IBM is already making some of its cloud-based services available through other cloud providers, such as the recently announced Watson on AWS, rather than keeping it exclusively on the IBM Cloud.
Refocus on its Core Software Strength
Jumping right into the cloud infrastructure fray may have proven to be a mistake for IBM, when its core strength is really within software for business applications, IT management and computing solutions, including its middleware class. An alternative strategy would be to focus on making IBM software and solutions available on all public and private clouds, preferably backed up by IBM’s hybrid cloud technology to ensure their coexistence and inter-operating capability.
Having the largest gross margin of almost 80% among all segments, IBM’s software segment (also known as cognitive solutions and excluding platform integration software and operating system software, part of the cloud-related segment and systems segment, respectively), is also the second largest revenue contributor behind the segment that combines technology services and cloud platforms. The segment sales comparison here seems to suggest that as IBM is able to grow cloud-related business, it has failed to maintain sales in the software segment and generate more profits from this higher-margin business. That’s rather peculiar because the presence of the cloud is meant to bring forth more software sales through easier access and more flexible use in the cloud.
It can be argued that a hardware company may further strengthen its business by adding certain software capability to its hardware offerings. But it’s not necessarily true the other way around. AWS may become more formidable now that it has developed its own big data solutions. But IBM’s cloud infrastructure pursuit hasn’t had a meaningful impact on its software business, when all the while it could just make its software offerings available on others’ cloud platforms. IBM’s ambition in its quantum computing systems, however, is a worthy hardware strategy, which has to proceed its potentially developing quantum-based super complex applications later on.
Refocusing on its core strength within software can prove to be a winning strategy for IBM’s ongoing business. A latest example would be the development of the IBM Multicloud Manager, an IT management software. It’s virtually needed by all cloud users that have their data centers on multiple clouds and thus need to better manage data and apps across all platforms. IBM’s Milticloud Manager may prove to be a hard-hitting software offering and potentially score a big win in its continued cloud fight.
Investor Note
IBM’s cloud pursuit is a mixed bag of good and bad at best. Any upsides that some people see somewhere can be easily cancelled out by downsides that others see somewhere else. The stock is essentially in a holding pattern and depending on how soon IBM can make the best use of all its cloud infrastructure investments, the stock can be in no rush to get back to its previous high of $200 level. But flashes of IBM’s brilliance can also prevent the stock from falling further. Also, having enough profits to pay dividends, IBM can be a good dividend stock with satisfactory yield but limited downside trading risk.
JW Investments Associates: Research & Management 