Victims Of The Changing Tech Landscape

by: Peter Pham

The global economic slowdown coupled with the changing market dynamics that comes from consumers preferring smartphones over personal computers has challenged the profitability of two leading technology firms; IBM and Intel (NASDAQ:INTC). IBM disappointed investors by posting lower than expected third quarter results while both companies are expecting the demand to fall in the coming quarters. So, in the face of a number of major product launches in the technology sector from Microsoft, Google and Apple, the sector is facing its toughest business environment in the past few years.

For the quarter ending September, IBM posted revenues of $24.7 billion representing a 4% sequential and 5.4% year-on-year decline while falling short of estimates by $700 million. Overall, IBM's revenues have declined in all operational areas. The biggest drop in regional revenues for IBM occurred in Europe where its sales fell by 9% coming from the weakening euro.

While revenues have fallen, net income has remained steady at $3.8 billion which translates in EPS of $3.62 in line with estimates. IBM's current profit margin of 15.4% is its highest ever this year recovering from 12.4% posted in the first quarter. However, the fact remains that IBM has missed its revenue targets which bodes poorly for the coming quarters. Following the release, IBM's stock plunged 5% on Wednesday which dragged the Dow, in which IBM is the dominant component, for almost the entire day.

The alarming aspect for IBM is the performance of its global technology services (NYSE:GTS) division, which makes up roughly 40% of the total revenues. The revenues from this unit fell by almost 4% year-on-year to $9.9 billion. In addition, the Hardware unit's revenues also slumped by 13% year-over-year to $3.9 billion.

By comparison, Intel, which has recently lowered its fourth quarter outlook, witnessed a sequential and an identical year-on-year drop in revenue of 0.3% and 5.4% respectively to $13.4 billion for its quarter ending September. Unlike IBM, Intel has not been able to sustain its income which has increased by 5% sequentially but fallen by 14.3% year-on-year to $2.9 billion. Margins on software contracts are generally higher than hardware, giving IBM more pricing leverage in a slowing economy, along with the complementary nature of hardware and software. This year, Intel's quarterly profits have failed to touch the $3 billion mark.

The future for IBM, despite the current fall, will remain stable in the long run. In the emerging markets of China, India and Russia, IBM witnessed strong growth numbers of 19%, 13% and 11% respectively. However, the current economic climate will likely pressure its revenue number in the medium term (2-4 quarters). The weakening global economy has forced its public and private customers to curtail their technology spending. This is expected to particularly dent the technology-consulting service and business-software products units. The continuous growth of the mobile market is pressing IBM, Intel and Microsoft (NASDAQ:MSFT) to innovate and adapt new technologies faster than they had in the past.

The future, without doubt, lies in cloud computing and mobile devices. In a latest move, IBM has recently introduced a new and relatively unknown form of cloud computing called Platform as a Service (NASDAQ:PAAS). Here IBM's customers can use the company's cloud platform to develop their own software and applications. This new and innovative product can help IBM drive in future revenues.

Meanwhile Microsoft is also pushing its Windows Azure's PaaS component, which now supports machines running on Linux as well. Azure is also gaining ground in the smaller players in this market, such as Appfog, which has now started supporting Azure. Unlike the desktop OS market, where Microsoft has enjoyed a monopoly for decades, in the cloud computing world, it is a small fish in a pond ruled by Amazon . Both IBM and Microsoft are expected to attract smaller firms for their PaaS as they gain acceptance in cloud computing. As far as PaaS goes, Salesforce's Heroku leads with clients such as Walmart, Activision Blizzard and GroupMe.

Intel, which is primarily a hardware manufacturer, is behind its competitors in mobile computing due to their pushing the performance envelope without considering power consumption. As the market for tablets and smart phones matures, Intel's biggest rival is no longer [[AMD]] but rather Qualcomm (NASDAQ:QCOM). Intel knows this and if there is one area where they have never skimped, it has been in R&D. Their problem, of course, is that Qualcomm is just as aggressive in its R&D spending and will continue to push the limits of the ARM V7 instruction set while continuing to integrate more services onto the SoC itself. The problem for Intel is their current Atom offerings simply cannot compete and there are serious worries over Clover Trail SoC's hitting the market at price points that would allow Windows 8 tablets to compete with anything running even a dual-core Qualcomm S4 or quad-core Cortex A9 chip like the Tegra 3 or OMAP 4 being used in the Surface RT and Kindle Fire. These are not the best ARM's licensees have to offer, their next generation SoC's are on schedule for early 2013. Clover Trail looks to be a bad stop-gap that may permanently dent Intel's future image.

Meanwhile, AMD is having its roadmap slip again due to incompetent management and the latest quarterly results came with another 15% of the workforce being slashed. According to some sources it's more of the engineering staff, which only makes the future look even more uncertain, despite the potential design wins in all of the next generation consoles. The problem, of course, is that those consoles, the next Xbox and Sony Playstation 4 are at least a year away.

AMD's "Fusion APU roadmap" is likely going to slip and push Kaveri out to the 2nd half of 2013, erasing any gains versus Intel they might have had made up with Trinity. By then Haswell will be out and AMD's lead in graphics performance will be thinned considerably. AMD's future will rely on them pulling in off-the-shelf ARM cores and mating them with their superior Radeon graphics technology. If they survive, and Intel's ineptitude at building a mobile SoC is again handing them an opportunity which they may not take advantage of with their Z-60 chip, also called Hondo, has been specifically designed for tablets and will be ready for shipment as Microsoft launches Windows 8. AMD is adapting quickly to the mobile market but its high debt ratio coupled with falling income and revenues creates doubts over the company's ability to deliver on its promises.

Intel's hopes are closely tied with its long time partner Microsoft's release of Windows 8 which it is hoping would drive the PC sales, but if this quarter's results tell us anything it is that the shift away from stand-alone PC's is happening faster than either company expected.

To review, IBM and Microsoft both need to promote PaaS to increase their income. Although it is expecting a slowing demand but IBM is currently looking to touch its year end targets which should send the stocks even higher by the end of the quarter.

The demand for the new version of Windows and the mobile products it has spawned looks to be solid given the early pre-order numbers, but the proof will be in the performance of these devices in the real world. At this point in time nearly all of these companies have serious questions hanging over them. IBM still looks to be the best positioned while Microsoft is a company in transition, competing in new markets it is unproven in. Intel and AMD have been blind-sided by the move to mobile and are wholly unprepared still for the low-power computing world.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.