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Recently IBM (NYSE:IBM) came out with its fourth quarter FY 2013 results, which showed that (as in the third quarter) the company was struggling with the declining hardware sales and continued decline in the so called self-defined growth markets. Due to both these factors, for the latest quarter, IBM reported a 5.5% decline in the revenues that went down to $27.7 billion from $29.3 billion a year earlier. However, the positive effect of some tax related issues allowed the company to report a decent 6% growth in the net profits that grew to $6.2 billion from $5.8 billion a year earlier. On per share basis, the earnings per share stood at $5.73, up from $5.13 per share during the same period last year.

Before going any further let's take a brief look at the segment-wise performance of the company.

  • Global Technology Services:

The segment generated about 36% of the company's revenues. The revenues for the segment declined 3.6% to $9.9 billion from $10.3 billion. The segment's gross margins improved by 120 bps to reach 38.8%. Pre-tax margins were at 19.5%, up 30 bps.

  • Global Business Services:

The revenues for the segment grew 0.6% to $4.75 billion from $4.7 billion. The segment's gross margins improved by 80 bps to reach 30.7%. Pre-tax margins were at 19.1%, up by 190 bps.

  • Software:

The revenues for the segment grew 2.8% to $8.1 billion from $7.9 billion. The segment's gross margins remained at about 90.5%. Pre-tax margins were at 47%, up by 100 bps.

  • Systems and Technology:

The segment reported revenues of $4.3 billion as compared to $5.8 billion a year earlier. The segment lagged behind on all fronts. The revenues showed a significant decline of 26.1% while the margins came down by 550 bps to touch 38.6% from 44.1%. Pre-tax margins were at 4.7%, down by a whopping 1170 bps.

  • Global Financing:

The segment generated revenue of $534 million, almost unchanged. The segment's gross margins declined by 50 bps to reach 43.3%. Pre-tax margins were at 49.6%, down by 30 bps.

During the quarter, the company's three out of main five reportable segments showed decline in the revenues while other two showed some positive trends. "Systems and Technology" segment, which accounts for most of the company's hardware sales showed a major decline in revenue with 26.1% decline. Though the other segments did not show such a steep decline, the performance can't be termed as encouraging.

Market reaction and the development after the result announcement:

The stock-market gave a thumbs down to the results, as the share price fell after the results and now is coming closer to its 52-week low (see the chart below).

The company is well aware of the fact that the dismal performance of the non-core business is dragging down the overall performance of the company. That is why, after the result the company came out with the announcement that the company has entered into a definite agreement with Lenovo under which Lenovo will acquire IBM's x86 server business. Lenovo is the same company, which acquired PC business of IBM way back in 2005. The business (x86 business) is the part of the company's "System and Technology" segment, the most underperforming segment of the company.

This is an excellent move (explained below) by the company as the business hasn't been getting the desired focus.

  • The agreement:

The company is selling its x86 server business at a price of $2.3 billion (approximately two billion of which will be paid in cash and the balance in Lenovo stock). Lenovo will get IBM's x86 server business, which includes:

"System x, BladeCenter and Flex System blade servers and switches, x86-based Flex integrated systems, NeXtScale and iDataPlex servers and associated software, blade networking and maintenance operations."

After the sale, IBM will retain its System z mainframes, Power Systems, Storage Systems, Power-based Flex servers, and PureApplication and PureData appliances.

  • Why it's a good move:

Over the last few years, the company has been going through a strategic transformation. The transformation is aimed to make the company a growth oriented company. The new strategy is focused towards building-up of the revenue streams that can give recurring revenues year over year. The company is focusing more and more on the self defined growth markets and growth segments (cloud, mobile, business analytics and security) to achieve its aim.

Due to the ongoing transformation, the company is increasingly becoming the company that offers "solutions as a service." The solutions include both "hardware as well as software as a service." The new strategy of the company doesn't go well with the standalone hardware selling, which is the prime revenue source for the segment. As the both ("solutions as a service" and hardware selling) needs a totally different and conflicting marketing/selling efforts.

  • Benefits:

Apart from letting the company to exit its non-core business, the agreement may also prove beneficial for the company in the future (as explained below).

Lenovo (the acquirer of x86 business) is a major player of PC and mobile market in the emerging markets. Lenovo is capable enough to leverage the combined power of IBM's technological expertise and its own low operating costs to grow the acquired business.

This will be beneficial for IBM on two accounts:

First, as IBM will continue to develop and evolve its Windows and Linux software portfolio for x86 platform, any growth in the business by Lenovo will lead to the higher software sales, which is a very high margin business.

Second, Lenovo and IBM are also planning to enter into a strategic relationship, which will include a global OEM and reseller agreement for the sale of some of IBM's industry-leading storage and software products. This strategic relationship will give a second chance to the company to enter the emerging markets.

A good move by the company is that it has taken the right step by selling whatever assets it can sell of its non-core business. This will allow the company to focus more on the growth segments where the company has been making significant investments. For example, the company intends to invest more than $1 billion in the new IBM Watson Group, and $1.2 billion to expand its global cloud computing footprint to 40 data centers worldwide in 15 countries across five continents.

Conclusion:

Since the last few years, the company is going through a transformation phase. The company has been increasing its presence in the higher-value areas, such as services, software and integrated solutions, with Smarter Planet, Business Analytics, and Cloud as its focused growth initiatives. The company's long-term outlook depends on how well the transformation is going on, or in other words, how well its services, software and integrated solution divisions are performing.

The quarterly results may not look encouraging as the company has been struck with the multiple problems, such as sluggishness in the growth markets, lower hardware sales, and currency fluctuations. However despite all these issues, the company reported margin growth for all of its segments* that generates the services, software and integrated solution related revenues. Moreover, its focused growth initiatives resulted in healthy growth for the quarter as well as FY 2013 (Smarter Planet grew 20%, Business Analytics grew 9%, and Cloud grew 69%).

*Global Technology Services, Global Business Services and Software segments.

The results look dismal, but the company is moving ahead smoothly and successfully with its transformation objectives though at a slower pace due to the issues that are either part of the company's transformation process (declining hardware sales, which is not its core-business or at-least not its focused business), or are industry specific (dismal growth in the growth markets, which is hurting all the companies in the industry). As the company is increasingly growing its presence in the fast growing segments, such as Smarter Planet, Business Analytics, and Cloud, the growth potential and the long-term fundamentals of the company are very much intact.

The company's agreement with Lenovo is a late but a very welcome move by the company, as the business is not getting the desired focus that leads to the steep decline in the performance. However, the sale doesn't mean that the company will totally exit the troubled data-center business; in fact, the company has only found the buyer for the assets that are showing some kind of growth (System x grew 15% at constant currency in Q4 FY 2013). The assets, which was responsible for the major revenue decline in the latest quarter, such as System Z (down 37%), power (down 31%), and storage (down 12%), will remain with the company -- probably the company hasn't been able to find a buyer for these assets, or the company just want to keep these assets, particularly its mainframe products (System Z) that according to company are performing very well, and the decline in the revenues is due to the fact that the mainframe product cycle has reached its backend. So, the revenues are likely to bounce back with the start of the new cycle. However, no bounce back is expected in the segment's performance in the near future. But, certainly a good move by the company.

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This article reflects the personal views of the author about the company and one must consult its financial adviser before making any decision.

Source: IBM: Results And The Subsequent Event