IBM's global services units are struggling to grow - Image credit: AFP via @daylife
Shares in IBM fell off a cliff on Wednesday after the company posted disappointing third quarter earnings. The weakness, particularly in the global services units, appears to be company-specific, rather than a malaise afflicting the whole sector, Bernstein Research’s senior analyst argued. At the end of the day, this will benefit “transformation-oriented” firms like Accenture, which will manage to escape secular challenges such as maturing markets and increased competition.
Investors suffered as IBM’s stock tanked more than 5% during Wednesday’s trading session, dragging the whole Dow into negative territory for most of the day. The company has had a hard quarter, and a hard last couple of quarters, delivering weaker than expected earnings as the stock seesawed through the last 12 months. IBM is such a large part of the Dow that despite only seven of the thirty Dow components being in the red, the whole index spent most of trading session in the red and only managed pop into positive territory by the last hour or trade.
IBM’s problem, according to Bernstein Research’s senior analyst, Rod Bourgeois, is its global services units. In the third quarter, IBM missed revenue estimates delivering $24.7 billion in sales, compared to the $25.4 billion expected; together, its business and technology services units saw revenue slide 0.3% on a constant currency basis (Global Business Services fell 3% to $4.5 billion from a year ago, while Global Technology Services saw growth slow to 1%, hitting $9.9 billion).
On the business services side, IBM’s weakness “is due to four IBM-specific factors […] rather than being largely due to a general market slowdown,” Bourgeois argues. IBM has put itself directly in competition with the likes of SAP and Oracle in its systems integration/ERP (enterprise resource planning) services markets by pushing its own software. “Why,” asked Bourgeois, “[because] IBM's primary focus overall is to grow its software business (which commands well-above-corporate-average margins), and a primary motivation for IBM's systems integration services business is to push/enhance/supplement IBM's software business,” he answered.
IBM" style="padding: 1px; color: #000; background: #ddd;" class="mceWPmore" type="organization" subtype="company" active="false" key="ibm" ticker="IBM" exchange="NYSE" natural_id="fred/company/2217">IBM, along with other traditional data center outsources, has also struggled to cross-sell, according to Bernstein Research, given increased competition. With Indian firms on the rise, it becomes increasingly difficult to keep their grasp on different data center services. This, in turn, shifts the engine of growth in the industry to “transformational services” (such as deals tied specifically to clients’ business outcomes), further fueling IBM’s loss of share in consulting and outsourcing categories, while firms like Accenture surge.
On the Global Technologies side, IBM is facing secular growth challenges. Traditional IT infrastructure businesses are seeing a maturing industry that, is driving weakness in sales of sales of add-on work and cross-selling. “Well-positioned IT services firms such as Accenture and Cognizant do not have material exposure to the traditional IT infrastructure business” as they transition into RIMO (remote infrastructure management outsourcing), Bourgeois explained.
His last point as to IBM’s weakness has to do with labor force “rebalancing charges.” IBM has restructuring its workforce, particularly in their global technologies services unit, “to reduce surplus labor in Europe,” Bernstein’s analyst noted, taking a little bit more of a hit on the bottom line.
Thus, despite a non-GAAP gross operating margin of 48.1%, IBM suffered a horrible post-earnings stock price drop. Bourgeois actually noted that within the computer services sector, his top picks are Cognizant, Sapient, Accenture, and ADP. IBM, then, is the victim of company-specific problems, according to the analyst, which are tied to its services operations.
