IBM Watson: The Growth Story Finally Unfolding

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Summary

IBM’s Watson has found an excellent revenue-generating source.

Siemens will include Watson in its MindSphere industrial cloud platform.

The development could act as a trigger to boost IBM’s stock price.

IBM (NYSE:IBM) jointly announced with the German conglomerate Siemens (OTCPK:SIEGY) that they are planning to include IBM's Watson in Siemens's industry analytics platform MindSphere. Siemens is Europe's largest manufacturing and electronics company with a worldwide presence. Siemens operates in the industrial sector with lots of on-premises software suites, which the company is willing to send to cloud. As a result, IBM's Watson will get a significant boost. This article investigates how IBM's Watson platform will benefit from the development.

How Siemens Will Use IBM Watson?

The development is a significant milestone for IBM's AI (artificial intelligence) platform Watson. In a previous article, I said that IBM's Watson, despite its huge success as a cognitive computing-based guided analytics platform, isn't witnessing enough growth primarily due to lack of use cases. Siemens's inclusion of Watson in its industry analytics platform, MindSphere, will significantly expand the use cases of Watson.

IBM's alliance with Siemens is nothing new for Watson. Before Siemens's current initiative of utilizing Watson in the industrial sector, the German conglomerate created a global strategic alliance with IBM to exploit the strength of Watson in healthcare. However, beyond healthcare Watson's use cases mostly revolve around finance, retail, and travel/hospitality, according to Deloitte. Deloitte said:

IBM Watson is designed to support business uses across a broad range of industries and functional areas. IBM is initially focused on developing solutions in areas such as customer engagement, healthcare, finance, retail, and travel/hospitality.

While customer engagement isn't an industry, what Deloitte wanted to mean is that Watson can be extensively used for engaging customers in the sectors specified in the quote. Just after coming into existence, Watson was supposed to support primarily these industries. Since then, the use cases of Watson didn't expand despite the fact that it has tremendous potential to thrive in the industrial and manufacturing sector.

I expect that IBM's deal with Siemens will be a game-changer for Watson. Siemens has an enviable track record of introducing new innovations to OEMs and application developers. Its MindSphere platform, which is basically a PaaS (Platform-as-a-Service) for the industrial sector, is the leading platform in the world. MindSphere offers cost-effective apps to the manufacturing industries across the world to allow them to benefit from the advantages of big data and analytics. The platform consists of a variety of tool for developers for enabling them to create specialized apps for industrial use. To put it into perspective, an app can allow a company to minimize manufacturing cost by adjusting output according to current input price in an automated manner. Watson's cognitive computing APIs will allow these developers to leverage the strength of the world's most sophisticated AI platform, i.e., IBM Watson, in building such apps.

MindSphere Is Based On SAP HANA: Great for Watson

The ultimate aim of the pact between IBM and Siemens is to deliver automation in the industrial sector by allowing developers to build intelligent apps utilizing Watson's AI capabilities on Siemens's industrial cloud. IBM is one of the world's leading cloud companies. Why would IBM need Siemens's cloud platform to deliver industrial automation?

IBM's cloud platform and analytics solutions are smart enough to extract insights from the data found in sensors of manufacturing systems and maintenance logs. However, lack of data-driven intelligent apps in the market results in wastage of data since benefits of IBM's cloud platform and analytics solutions can't be fully realized. Why there are such problems?

Investors should remember that although IBM is a prominent cloud and analytics player, it's not the world's largest provider of on-premises industrial software suites, which lies in the domain of Siemens. And Siemens is aiming to take these software suites on the cloud.

Siemens will do the job via its MindSphere platform, which is based on the SAP (NYSE:SAP) HANA cloud platform. And this is great news for IBM. Why? IBM and SAP are already partnering "to drive the modernization of clients' systems and processes and accelerate them into the digital economy." But HANA also has analytics capabilities. Then what role will Watson play in MindSphere?

Combination of Watson and HANA Is What Developers Need

Although both Watson and HANA have analytics capabilities, those are non-competitive platforms. While Watson is a full-blown AI platform while HANA is primarily an in-memory database platform with a few analytics capabilities. But it should be noted that HANA's analytics APIs are more industry-oriented compared to that of Watson. For example, HANA's Spatial APIs help enterprises store their geospatial data alongside business data on HANA, and its Graph APIs help enterprises perform graph-based data processing. Click here and here to learn more.

Since Watson can't perform complex mathematical computation, predictive analysis and inductive reasoning (to learn more, click on the Deloitte link presented above), without the support of HANA, it won't be able to grow in the industrial sector. In contrast, HANA has a rich predictive analysis library, popularly known as PAL. Combining the diverse capabilities of Watson and HANA, developers will be able to build truly intelligent apps for industrial use. A lot of these apps will be Siemens's off-premises version of its existing on-premises software suites.

How IBM Will Benefit?

IBM will be directly benefited. Watson's use cases remained more or less stagnant since IBM launched Watson. The company's third-quarter 2016 revenues from the company's strategic imperatives, which include cloud, analytics, mobility and security, grew 16% YoY. However, despite such meaningful growth, IBM didn't break out results for Watson, which generates revenues via its partner program called Watson Ecosystem. Developers, including companies and startups, participate in the Watson Ecosystem to earn revenues and share their revenues with IBM via a 70/30 revenue sharing model. IBM isn't interested to break out Watson's revenues anytime soon, the company said.

Clearly, Watson's contribution to IBM's overall revenues is still insignificant. However, that's going to change in the coming quarters. Since the industrial space is a large sector covering lots of smaller sectors including defense, aerospace, automotive, electronics, chemical engineering etc., Watson's use cases and revenues will increase significantly as a result of the recent pact between IBM and Siemens.

IBM's revenues from its Cognitive Solutions segment, which includes solutions software and transaction processing software, came in at $4.2 billion in the third quarter. Revenues from solutions software, which includes Watson and other data analytics platforms, grew 8% YoY. This is encouraging indeed from investors' point of view.

IBM offers a few services based on Watson, such as Watson Discovery Advisor, Watson Analytics and Watson Explorer. I believe these services generate the majority of revenues from Watson, instead of core Watson APIs. In addition, Watson indirectly drives revenues, which IBM shows in other reporting segments, e.g., Global Business Services and Technology Services & Cloud Platforms. Per my estimate, IBM's quarterly revenue from Watson (including revenues Watson indirectly drives) currently stands at somewhere below the $1 billion mark, which is about to cross $1 billion in the near-term due to the Siemens deal. The deal will engage more developers to create industrial apps based on core Watson APIs.

Conclusion

IBM's share price touched almost $170 before retracing a little. In 2017, I expect the stock to breach the $200 level, and finally create new highs. The fact that Watson has found a solid market to expand its use cases and revenues will act as a trigger to take IBM's stock to new highs.

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.

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