Introduction: MarketWatch columnist Therese Poletti writes that due to IBM's consistently underwhelming performance, confidence in the company on Wall Street is not what it used to be. However, CEO Ginni Rometty still has a chance to solve these issues, and the company's future remains to be seen.
Below is the full commentary by Poletti:
Could it be that IBM is no longer the money-making machine it once was in the eyes of Wall Street?
IBM (IBM) reported disappointing third-quarter results last week, missing revenue targets by $1 billion, naturally prompting investors to ask this question. In recent days, IBM's stock has lost nearly 7%, hitting a two-year low on Thursday.
The sharp decline in revenue is primarily attributed to IBM's hardware business, where the rate of decline has suddenly accelerated, especially for their high-end Unix systems. Notably, hardware sales in China dropped by as much as 40%, partly due to an economic reform plan and partly related to execution issues.
IBM's quarterly revenue was $10.5 billion, flat compared to the same period last year. Of course, most investors have long stopped viewing them as a growth company. However, due to their generous dividend payout (currently $0.95 per share), ongoing stock repurchases, and double-digit profit growth, the stock continues to be favored by many.
The problem lies in the fact that the significant drop in hardware revenue isn't their only disappointing news. IBM's earnings slightly exceeded Wall Street's consensus expectations only because the tax rate was lower than previously forecasted.
"In the past three quarters, IBM has missed revenue expectations twice, and there were also issues with profits, which is very rare," UBS analyst Steve Milunovich downgraded IBM's rating to neutral and reduced his 2014 financial forecast for the company. He stated that although the company's performance might improve in 2014, he believes the next two quarters "probably won't be very encouraging."
He wrote in his research report last week: "Poor recent performance, along with questions about their ability to grow profits in the future, are things we cannot ignore."
CEO Virginia Rometty quickly took action. The Wall Street Journal reported last week that in an internal email to employees, she expressed her concerns, stating that the company needs to "do better." In the email, she wrote: "Our culture is that performance determines income, and all of us have a responsibility to take action to address our underperformance."
Rometty also made adjustments to the leadership team, removing senior vice president James Bramante, who had been responsible for the company's various growth businesses, including those in China.
IBM's competitor HP (HPQ) has also encountered similar difficulties in its high-end hardware business. These businesses have been affected because some enterprise customers are abandoning their expensive server products in favor of cheaper, commodity-based servers they build themselves.
Although there are indeed industry-wide trends at play, IBM's miss on expectations was too large for some observers not to start questioning whether the company itself has problems. "A key question is whether IBM's weakness is based on macro industry issues or is unique to them," Bernstein Research analyst Toni Sacconaghi pointed out in a research note, noting that IBM's poor software performance and troubles in the Chinese market "are increasingly concerning compared to other players in the industry."
However, Sacconaghi does not believe that IBM's profit machine has broken down. "Ultimately, we believe it's not the case; the deterioration in company performance is mainly due to issues in the hardware business (and to some extent, the rapid change in the yen exchange rate), which is not a particularly serious problem going forward," he said.
Nevertheless, it is undeniable that the tone on Wall Street is changing, with some analysts doubting whether the company can achieve its long-term goal of $20 per share in earnings by 2015. Milunovich stated that although he believes the 2015 target is "still attainable, but no longer easy," the "company's credibility is now indeed very low." FactSet Research data shows that 55% of analysts have given the stock a "hold" rating, up significantly from 48% in the previous quarter.
Brian Marshall of ISI Group believes that IBM "needs to pursue bolder and larger-scale" acquisitions rather than just considering smaller, less prominent companies as it has done in the past.
However, since taking office in January 2012, Rometty has been under pressure but has continued to address IBM's issues. Investors will continue to wait and see how she deals with the growing distrust from Wall Street.