IBM’s Q3 2017 Earnings – Measuring the Progress of Self-Reinvention

By Charles King, Pund-IT, Inc.  October 25, 2017

Tech vendors reinvent themselves so often that it qualifies as a spectator sport in Silicon Valley. Strategic repositioning is necessary due to continually evolving technologies, from constantly shrinking semiconductors to massive cloud-scale data centers to increasingly complex data sets to ever-more sophisticated software. Vendors that fail to parse the import of these issues or respond incorrectly can quickly find their businesses descending toward irrelevance.

But other issues also demand vendors’ attention. Evolving technologies often spark new behaviors among consumers and businesses, rippling the competitive landscape like a tectonic wave. That can panic a vendor’s customers and partners, leading to other problems. And in a world driven by information, some can sometimes be driven mad, including shareholders who nervously sniff the data-laden wind in a panic over where a missed rumor or muffed signal might lead.

How companies approach these issues varies widely. However, IBM’s recent Q3 2017 earnings results show how a vendor can effectively face these and other challenges while fundamentally reinventing itself.

IBM’s reinvention process

It’s important to note that IBM’s reinvention has not been hastily organized or implemented. In fact, elements of the company’s five “strategic imperatives” (social, mobile, analytics, cloud and security) have been in development for over a decade. One example; the company’s focus on advanced analytics (which provides the foundation for the Watson cognitive platform and solutions that underlie many of its service and business initiatives) was initiated in 2005, leading to over $26B in related investments.

Some strategic efforts were kick-started with significant acquisitions. For example, IBM began buying cloud-related organizations and assets in 2007 but the $2B 2013 deal for SoftLayer more than doubled the size of the company’s global data center facilities. That, in turn, allowed IBM Cloud to quickly spin-up solutions designed for the needs of its core customers and enabled the company to seize and maintain its leadership in enterprise cloud services.

Others, such as Watson, were sparked by organic development of homegrown technologies. In fact, IBM has done a superior job of enhancing and evolving traditional products, including its Z Systems mainframe, Power Systems servers and storage offerings, as well as its core Db2 database and associated analytics and business intelligence solutions. As a result, the company can confidently provide customers the contemporary products and services they need immediately while helping them adapt to new technologies and trends.

The point of this history lesson is to highlight how strategic transformations—at least those which eventually succeed—are anything but capricious. Instead, they depend on a company formulating an unclouded vision of the goals it plans to achieve, committing the investments and effort needed to make them real, providing unwavering support for customers and partners during the process, and forthrightly addressing shareholders’ concerns along the way.

That may seem a bit mundane compared to the magical thinking and tertiary optimism prevalent among many high-tech start-ups and hot prospects. But it’s the way that companies built for the long haul tend to do things.

Q3 2017 results

So how did IBM do in this most recent quarter? Pretty darned good, overall. Taking a broad view, quarterly revenues ($19.6B) handily beat street estimates of $18.57B and came within a 0.4% hair ($73M) of being flat YOY. IBM’s EPS also surpassed analyst expectations ($3.30 per share vs. estimates of $3.28 per share), also delivering a $0.02 increase from Q3 2016.

It’s worth noting that this is the eighth straight quarter IBM has beaten analysts’ EPS expectations, and the company also reaffirmed its full-year guidance of $13.80 EPS, a sizable uptick from FY 2016’s $13.59. In addition, operating pre-tax profits for the quarter were $3.6B, up nearly 3 points YOY and free cash flow rose by $100M YOY to $2.5B.

That last point reflects IBM’s general strength, as well as its ability to regularly return cash to investors without weakening its ability to make critical strategic investments. Paybacks in the form of IBM dividends—some $5.50 in the company’s last FY—are far more generous than dividends from competitors, like Cisco ($1.07), Oracle ($0.60) and HPE (a woeful $0.07). In turn, robust dividends and share repurchases have made IBM a favorite of large scale “buy and hold” investors, including massive pension funds.

How about IBM’s strategic imperatives (social, mobile, analytics, cloud and security)? More good news. After growing 10% in 1H 2017, the group’s revenues notched 11% in Q3. That included standout performances by IBM Cloud (up 20% YOY, cloud now drives a fifth of all company revenues), security (up 49% YOY, in large part due to strong response to IBM Z System mainframe’s support for end-to-end encryption) and analytics (up 5% YOY, as Watson and other advanced analytics permeate IBM solutions).

More importantly, total revenues from the five businesses reached $34.9B during the trailing 12 months, accounting for 45% of all company revenues. Related to this, IBM stated that it remains on track for revenues from strategic imperatives to hit $40B or roughly 50% of company revenues by 2020.

Why is the success of these efforts so important? Because they help balance out the uncertain fortunes of some traditional IBM offerings. It’s not that those businesses are faltering but they are becoming increasingly cyclical, with sales dependent on and varying significantly due to generational upgrades. In fact, some of those traditional businesses fared well during the quarter.

IBM Systems, for example grew by over 10%, and cognitive solutions linked to analytics software and services were up by 4%. The success of Systems is partly due to healthy uptake of the new generation Z System solutions whose ability to deliver end-to-end data encryption without impacting overall performance struck a nerve with enterprise customers. In addition, IBM Storage’s sales enjoyed 4% growth during the quarter as customers continued to embrace the company’s refreshed portfolio and all-flash FlashSystem solutions.

Final analysis

What are the takeaways from IBM’s Q3 2017 results? In essence, the quarter reflects the company’s ability to balance delivering products and services fitting customers’ current business needs while proactively developing future-focused solutions.

Neither effort can exist in a vacuum, and dismissing one for the other can have lasting, negative consequences. Ignoring existing hardware and software solutions (as too many vendors ruefully learn) can leave customers lurching to keep up with better-prepared competitors. Focusing too much on contemporary technologies opens clients to damage from disruptive innovations.

IBM’s investments in its social, mobile, analytics, cloud and security businesses deliver clear benefits across the whole company. However, the continuing success of those five strategic imperatives reflects a highly effective, evolutionary transformation that IBM has been planning and executing for years. Silicon Valley isn’t the only place where companies’ cheery promises and optimistic claims about evolving themselves belie what they do. In contrast, IBM’s performance in Q3 2017 shows how self-reinvention is and should be done.

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