International Business Machines (NYSE:IBM) beat estimates for its fourth quarter, but analysts yawned.
GAAP earnings of $6.7 billion, or $4.11 per share, and revenue of $21.8 billion were ahead of last year’s figures. Revenue at Red Hat, the company’s cloud software unit, rose a solid 24% year-over-year.
But IBM has had strong fourth quarters before, said Morgan Stanley analyst Kate Huberty, who cut the stock’s rating from “overweight” to “equal weight.” Numbers were once again bolstered by a strong mainframe launch. But key profit centers like on-premise infrastructure, consulting and outsourcing are still draining revenue as fast as it can be replaced.
Worse, IBM seems to have shot its financial bolt with the $34 billion Red Hat purchase. Cash is down to $8.9 billion, long-term debt is at $54 billion. There doesn’t seem to be room for another big deal.
Get in the Cloud
If IBM wanted to be bold, it might buy a data center real estate investment trust (REIT) like CoreSite (NYSE:COR), worth $4.4 billion, or CyrusOne (NASDAQ:CONE), worth $7 billion. Alternatively, it could deploy its cash to create one, built around its SoftLayer unit, now known simply as IBM Cloud.
IBM needs to get assets close enough to the big clouds of Amazon (NASDAQ:AMZN), Microsoft (NASDAQ:MSFT) and Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) that there is no penalty to companies storing applications or data on its assets. As it is, the company may be too small to compete against those big names. The market capitalization of $121 billion is a tiny fraction of Amazon’s $925 billion, Google’s $994 billion or Microsoft’s $1.3 trillion.
VMware (NYSE:VMW), which is Red Hat’s main rival in cloud container software, is now worth $62 billion. Dell Technologies (NYSE:DELL), which owns 80% of it (along with its debt), is valued at $36 billion. This is now IBM’s competition.
After becoming CEO in 2012, Virginia Rometty spent years milking those failing units for stock buybacks and dividends. In the process the share count dropped to just 885 million. IBM’s $1.62 per-share dividend now yields 4.7% but costs about $1.4 billion per quarter to service. The company said after buying Red Hat it would stop buybacks for the next two years.
New Pilot Needed
The next catalyst for IBM bulls could be Rometty’s retirement, and her replacement by Red Hat CEO Jim Whitehurst. IBM CEOs traditionally retire at age 60, and Rometty is 62. Whitehurst is 53 and might be considered too old to take the top job in a few years.
But Whitehurst understands what IBM must do, in terms of its organization, management and product, to become relevant again. He’s respected in Silicon Valley in a way no IBM leader has been since the valley was filled with fruit trees. His book, The Open Organization: Igniting Passion and Performance, is practically a road map for the changes that could get analysts on the company’s side. Right now, IBM is worth only 25% more than its annual revenue. Most cloud companies are selling for 8-10 times revenue.
The Bottom Line on IBM Stock
If Whitehurst is bypassed — if he leaves the company or if Rometty hands the title off to another nice marketing person, an IBM life-er — investors need to stop what they’re doing, ignore the fat yield and sell IBM immediately.
Only a new pilot who understands how tech works in the 2020s and can get breakthroughs from IBM labs into the market quickly, is going to save this company. We know Rometty isn’t it. Whitehurst might be. He’s IBM’s Obi-Wan Kenobi, and I think its only real hope.
Dana Blankenhorn is a financial and technology journalist. His latest book is Technology’s Big Bang: Yesterday, Today and Tomorrow with Moore’s Law, essays on technology available at the Amazon Kindle store. Write him at firstname.lastname@example.org or follow him on Twitter at @danablankenhorn. As of this writing he owned shares in AMZN and MSFT.