IBM: What More Does The Market Want?

| About: International Business (IBM)
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IBM beat analyst estimates when it reported quarterly earnings.

The stock fell.

What more could the company have done?

IBM Corp. (NYSE:IBM) reported earnings on October 17th. The stock price promptly fell 3%. But here's the thing - the earnings report was actually pretty good. If good news is bad news, what is it that investors are looking for?

A solid beat

Analysts watching IBM were looking for the company to bring in $19 billion in revenues and to report adjusted earnings of $3.23 a share in the third quarter. The over 100-year old computer giant beat on both accounts, reporting $19.2 billion on the top line and $3.29 in adjusted earnings per share. And investors were clearly displeased with the stock falling 3% while the broader market advanced.

The truth is, the underlying numbers have been pretty good at IBM. For example, revenues in the so-called strategic imperatives have advanced 16% so far this year. These are the businesses on which IBM is focusing for the future, including cloud, analytics, mobility and security. It's exactly where you want to see double-digit growth. And the new "hot" sector, cloud computing, has put up astounding numbers, growing roughly 65% so far this year. Overall, about 40% of the company's revenues are now derived from this collection of businesses.

But this wasn't enough to keep investors happy. To be fair, IBM shares are up nearly 10% so far this year even after a recent pullback. That's roughly twice the market's around 5% gain. So, perhaps the stock decline on decent earnings has more to do with the above market gain than anything else. Still, this appears to be a "good news is bad news" situation.

Slow turn

The fact is, IBM remains a company in transition. And it will continue to be a company in transition for a while longer. Essentially, it is working to reposition itself for a future that is very different from the past. If IBM were a $1 billion market cap company that's been around for a decade or less, you'd expect such a shift to be quick - like turning a small sailboat. But this is a $140 billion market cap company that has been around for 100 years. Making changes at a company as big as IBM is like turning a giant cruise ship capable of holding thousands of people.

In other words, IBM can only move just so fast. Granted, it has been a long time, with revenues now lower year over year for the 18th consecutive quarter. Divide that by four, and you see that IBM's top line has been declining for four and a half years. That's clearly not a good sign, and investors can easily be excused for being a little bit concerned.

But based on analyst estimates, no one expected to see that trend turn around in the quarter. In fact, IBM is really charting a difficult course. It has to keep its current portfolio of offerings delivering (even while they are in a long-term secular decline), while at the same time shifting gears to a new model that emphasizes very different products. Put a different way, it has to milk the cash cow without killing it so it has time to replace the slowly dying cash cow with new businesses.

That's not easy, and many companies through history have failed to pull off such a shift. But IBM has done this before - several times in its own long history. You don't get to be 100 years old without being able to adjust with the times. And here's another important fact: the company's GAAP earnings were $2.98 a share in the quarter, with adjusted earnings coming in at $3.29 a share. IBM remains wildly profitable, which gives it a great deal of leeway as it makes this complex and difficult journey.

I still like the story

I can't say that I think IBM is trading at bargain prices today. However, I can say that it's still making admirable progress toward its goal of changing with the technology times. There's nothing in the second-quarter earnings to suggest otherwise. And it's that story that remains most important right now. If you are an investor, ignore the market's reaction to IBM's earnings. Sure, there was bad news in the earnings release, but the really important stuff was all good.

Disclosure: I am/we are long IBM.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.