IBM (IBM, Financial) changed its reporting segments earlier this year to help investors understand and gain more visibility into the changing nature of its traditional and futuristic business lines. It also started providing standalone numbers on several individual business lines such as analytics, mobile, cloud, security and social, calling them the “strategic imperatives.”
The real reason was that there are several parts of IBM’s legacy business that were slowing down, while many new and relatively small individual business units were growing. In the name of transparency they gave more detail to their performance which, in a way, also helps us understand the subtle undercurrents that are developing within IBM.
A Bet Called Analytics
We keep hearing about the growth of the cloud industry and with IBM pushing hard in that area, their cloud business hogs most of the limelight during their earnings calls. The reason is that it easily lends itself to becoming a focal point in any discussion about IBM, Amazon (AMZN, Financial), Microsoft (MSFT, Financial) and Google (GOOGL).
But, there is one more area that has been flying under the radar which I believe can develop into a strong driver for IBM’s future - and is possibly in the best position to even help the other strategic imperatives of IBM, analytics.
IBM reported $4.9 billion in revenue from analytics during the second quarter of 2016, a 4% year-over-year growth. Analytics grew 9% during the first quarter to reach $4.2 billion in quarterly revenues. With almost $5 billion in revenues, analytics alone enjoys a run rate of nearly $20 billion in annual revenues for IBM and it is still growing.
IBM says the revenue numbers do have an overlap with services delivered via cloud and, unfortunately, we cannot separate them because IBM’s analytics is very much an “as-a-service” offering. The idea behind this is that only when delivered via cloud can its true potential be harnessed. So for all practical purposes, there is no way we would able to separate one from the other.
IBM’s analytics segment, including those that were delivered via cloud, reached $4.9 billion in quarterly sales, which is 24.2% of IBM’s second quarter earnings of $20.2 billion. That is a significant contribution that I think will grow even bigger over time.
Q2 of 2015 Earnings Call:
“We are clearing seeing this in analytics where our revenue is up more than 20% in the first half, well above market rates. This is terrific growth on a large revenue base. Recall we generated $17 billion of analytics revenue last year.”
Q4 of 2015 Earnings Call:
“With nearly $18 billion of analytics revenue, we’re also the largest analytics provider, and we’ll extend that lead by moving into new areas including Watson Health and Watson Internet of Things.”
Q2 of 2016 Earnings Call:
“Our Analytics business is the largest portion of the solutions software portfolio. Analytics grew in key areas including Cognos, information integration and big data, and of course Watson as we add to our capabilities.”
So, clearly, IBM generated $17 billion in revenue from the analytics segment in 2014, which grew to $18 billion in 2015, representing a 5.8% growth.
In the first six months of the current fiscal, IBM has earned $9.1 billion from this segment and I would not be surprised if IBM makes it to the $19 to $20 billion range from analytics for the entire fiscal year.
Watson - The Heart of IBM Analytics
IBM has put Watson right in the middle of this segment and is structuring its offerings. They started with Watson Health and today IBM is pitching IT security teams to harness Watson’s power to stop cyber threats.
Though their cloud business and other strategic imperatives will be the biggest beneficiaries of having Watson as their “brain”, the capabilities of Watson go well beyond what the strategic imperatives represent. In a sense, I think IBM’s future will be analytics, with the platform being the cloud.
Watson - An Overview
You would be forgiven for thinking that Watson was named after Sherlock Holmes’ famous sidekick Dr. John H. Watson. The “question answering computer system”, as Wikipedia calls it, was actually named after IBM’s first CEO, Thomas J. Watson.
Preceded by Deep Blue and Piquant, Watson was officially born when IBM took up the challenge of playing popular game show Jeopardy! against live humans. From 2005 until 2010, Watson was “in training” for its Jeopardy! try against two of the best players in the game.
In 2011, Watson beat both players and won $1 million in prize money. This was a significant achievement for IBM because it paved the way for the IBM Watson Group, which was formed in 2014 with Senior VP Michael Rhodin at the helm.
Well before then, Watson had made a name in healthcare analytics, especially in the field of oncology where it was used to recommend treatments for lung cancer.
Today, Watson Health is just one of the many applications of this supercomputer. But the fact remains that most of Watson’s offerings reside on the cloud. Because of the sheer volumes of data that it deals with from every corner of the globe, it became necessary for the majority of Watson’s capabilities to be cloud-enabled.
The Bigger Picture
Analytics is simply a small part of the larger picture and that picture is called artificial intelligence. Every tech company wants to be on the AI bandwagon - from Microsoft to Apple (AAPL, Financial) to Facebook (FB) to Google, every company with deep pockets and access to tons of data is already in the game, whether they choose to or not.
As for Watson, artificial intelligence is an understatement. Its capabilities far outstrip anything that Apple’s Siri, Amazon’s Alexa, Microsoft’s Cortana or Google Now currently offers.
As an investor, Watson is the component that you need to watch whenever it is time for an earnings call. As we progress through fiscal 2016, you will see them hitting $14 to $16 billion in YTD revenues at the next quarter results and then ultimately in the range of $19 to $20 billion for the full fiscal.
In fact, with the competition in the cloud space tightening around their business, I see analytics ultimately taking over cloud as IBM’s biggest growth engine. As I mentioned, however, since it is delivered primarily on the cloud, these two components of their strategic imperatives are inextricably intertwined. That is, at least for us mere mortals who are not privy to Watson’s actual numbers. To the people on the inside, that’s elementary, my dear Watson.
Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.
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