(The author is a Reuters Breakingviews columnist. The opinions
expressed are his own.)
By Robert Cyran
NEW YORK, Aug 20 (Reuters Breakingviews) - IBM's (IBM.N)
earnings engine is making sputtering sounds. The tech giant
missed projections for the first time in years last quarter. Big
Blue characterizes these as mere speed bumps. And Chief
Executive Ginni Rometty appears hell-bent on making $20 per
share in 2015, by the company's measure of earnings. That’s
almost a third more than it earned last year. Pressing on the
accelerator of job cuts, software acquisitions and select
disposals has worked well so far. But some of the smartest money
on Wall Street is betting the company has a bigger problem, with
falling sales pointing to a hole in the gas tank.
Earnings per share have increased far faster than revenue at
IBM, doubling in five years against top-line growth of just 6
percent in total. This reflects increased efficiency at the
group's big consulting arm. Low-margin hardware businesses have
been sold or managed for cash. The proceeds have been used to
buy back stock, pay dividends, and acquire more profitable
software companies. Investors have seen a 20-fold return over
two decades, leaving the company valued at more than $200
It's a smart way to keep the bottom line increasing, but the
company may have squeezed as much as it can from this stone.
Gross margins have increased 6 percentage points over the past
five years. And software already accounts for 45 percent of
IBM's profit, so additional acquisitions and disposals should
have an increasingly less positive impact. Efficiency drives
also show diminishing returns - eliminating trash cans and
mandatory furloughs for employees in its hardware division are
one-time fixes. Firing U.S.-based consultants and sending work
overseas offers more durable cost cuts, but it can only go so
far before quality and reputation suffer, and foreign costs
Keeping profit on an upward trajectory is a struggle when
revenue shrinks. Sales fell 3 percent in the last quarter
compared to a year ago, with services and hardware bearing the
brunt. That’s the fifth quarter in a row revealing a yearly
decline. IBM blamed a poor economy. But there are hints that
increased use of on-demand software may be taking a bite. And if
revenue is down because costs have been cut to the bone, or
research and development underfunded, attempting further savings
could be long-term counterproductive.
IBM's method of measuring success also raises questions.
Officially reported earnings per share fell 13 percent in the
most recent quarter from a year earlier. IBM's definition of
income showed the figure rising 8 percent because of the way it
accounts for pensions, acquisitions and layoff costs. IBM claims
this is a better measure of the company’s underlying performance
because performance of its huge pension fund fluctuates with the
market, and the company is aggressively slashing costs. That
means it has to spend money today on things like severance, with
higher margins resulting in the future. IBM thinks the
underlying business, however, is becoming more profitable.
Adding confusion to the mix is an investigation by the
Securities and Exchange Commission into how the company books
revenue for its cloud-based businesses. Both IBM and the
watchdog remain tight-lipped on the matter and the fast-growing
business is prone to accounting disputes, so there's no way for
an outside observer to say whether there's a problem.
That's why it's important for investors to look at free cash
flow – the most concrete measure of how most companies are
performing. It's falling at IBM: in the first half of the year,
free cash flow has shrunk about 20 percent, or more than $1
billion. The company already spends most of its cash flow on
buybacks, dividends, purchases of software companies and
investments in its business. There's no danger of immediate cuts
– the sale of its underperforming server business, for example,
could generate $5 billion of cash, according to analysts. But if
cash flow continues to fall, it could mean a problem for the
company further down the road.
IBM’s reputation has always been conservative and corporate.
But it has been many years since the company faced such a
variety of perplexing questions and concerns about its accounts
and the sustainability of its profit machine. At the very least,
returning to a focus on earnings using the generally accepted
accounting principles method would reassure investors of the
group's blue-chip bona fides.
SIGN UP FOR BREAKINGVIEWS EMAIL ALERTS:
- On Aug. 15, IBM announced that it had agreed to buy
Trusteer, an IT security firm based in Boston with offices in
Israel. The price was not given, but Reuters sources said IBM
paid close to $1 billion.
- For previous columns by the author, Reuters customers can
click on [CYRAN/]
(Editing by Rob Cox and Martin Langfield)
Keywords: BREAKINGVIEWS IBM/
(C) Reuters 2012. All rights reserved. Republication or redistribution of
Reuters content, including by caching, framing, or similar means, is
expressly prohibited without the prior written consent of Reuters. Reuters
and the Reuters sphere logo are registered trademarks and trademarks of
the Reuters group of companies around the world.