Until a couple of months ago, I believed IBM’s (IBM, Financial) turnaround was gaining traction and the company was back on track. At the end of last year, it seemed that the group’s so-called “strategic imperatives” divisions, on which it is relying to reignite growth, had reached an inflection point, and growth in these categories would offset revenue contraction across the rest of the business, producing overall income and profitability expansion.
Unfortunately, at the beginning of this year it became painfully apparent that this was not the case and rather than closing in on the turnaround, IBM was, in fact, getting further away from a turnaround than ever before. The company’s second-quarter results only confirmed this trend.
Sales contracting
Revenue from the so-called “strategic imperatives” rose 7% after adjusting for currency swings, a slowdown from the 13% seen in the first quarter of the year. And once again, the company relied on one-off factors such as tax rebates and reductions to boost the bottom line. Stripping out these one-off factors IBM’s pretax profits have declined at a staggering compound rate of 10% per annum over the past six years.
Originally, my thesis for IBM (and that of Warren Buffett (Trades, Portfolio)) was that the company was too big to fail in its sector. Big Blue’s presence in the technology world and corporate talent would ensure that customers continue to return to the company year after year and make use of its new tools and AI platform. This growth hasn’t materialized and now the company is at risk of being steamrolled by the likes of Amazon (AMZN, Financial), Microsoft (MSFT, Financial) and Google, who have been able to innovate faster and produce more customer friendly platforms.
That’s not to say that IBM has not created something worth buying. The firm’s Watson super computer is a fantastic piece of technology, but how much longer it can remain so is unclear.
Losing the moat
A recent analyst report from Jefferies makes it clear the uphill battle IBM is facing. While IBM has spent over $20 billion developing Watson and buying data businesses to complement its offering, the sheer complexity of using the supercomputer is apparently putting off customers. Customers can quite easily go somewhere else. Tens of billions of dollars are being invested in AI, and deep learning technologies around the world, and almost every large business is now developing its tech. IBM is no longer the only option, and even though the company might have the best tech, competitors are catching up, and mass market customers don’t want/need to pay for the firm’s expensive/complicated offering.
IBM has lost its moat. Before, the company was really the only choice big firms with big IT systems had. Now, companies have the option of companies such as Microsoft or Amazon, and there are thousands of smaller companies also operating in the same space offering different functions. The connectability of these platforms has also vastly improved over the past few years so there’s no need to have one primary operator.
That being said, there are some markets where IBM’s size still means that it’s the only real option. For example, in 2015 the company won a cloud contract with Marriott (MAR, Financial)Â and at the end of 2014 the company won a $1.3 billion deal with WPP to bring together the operations of more than 300 agencies it has bought up over the previous decade.
At the beginning of this year one of the U.K.’s largest banks signed a seven-year, 1.3 billion pound ($1.693 billion) deal to outsource some of its IT to IBM. In 2013 the company won a 10-year, $1 billion U.S. federal cloud contract with the Department of the Interior so there are still big deals for the group, but it’s unclear how much longer large clients will continue to approach the business. As competitors grow in size, gain trust and build reputations, the company will start to lose this edge as well.
Overall, IBM has lost its competitive advantage, and the company may never get it back.
Disclosure: the author owns no share mentioned.
