IBM - International Business Machines

[Palantir]

I'm guessing that the investors who want IBM's price to languish so IBM can buy more may end up disappointed. If the investor community pressures VR to make acquisitions like CRM....that's going to mean less cash for buybacks.

[CorpRaider]

To my knowledge BRK is by far and away the largest shareholder (and all the ones even in the same zipcode are index and diffuse mutual funds), so until we hear some rumblings from them, I think management will be left to its devices.  Rommety already talks about viewing one of her primary jobs as capital allocation, so I'm pretty sure she's on board with WEB.  Of course BRK's % ownership goes up with each buyback, so long as they hold.

 

 

Are "cloud" and "software as a service" just some trendy tech consultant, venture capital, b.s. euphemisms for lease versus buy cap ex decisions?

[LowIQinvestor]

I am not in the camp of wanting it to languish for years.

But a BIG drop, followed by a massive buyback, followed by a stock that goes up for years to come....that sounds nice :)

[KCLarkin]

Are "cloud" and "software as a service" just some trendy tech consultant, venture capital, b.s. euphemisms for lease versus buy cap ex decisions?

 

It's a little more nuanced than that. It's not just about Capex. You are also outsourcing operations.

[oddballstocks]

Are "cloud" and "software as a service" just some trendy tech consultant, venture capital, b.s. euphemisms for lease versus buy cap ex decisions?

 

Interesting perspective, I would disagree.  SaaS and cloud moves management from your network to someone else.  Features can be rolled out universally quicker, and adoption is easier because the software is platform independent.  The support cost is moved from your own company to someone else.

 

SaaS has enabled a lot of smaller companies access to software that wasn't available years ago.  Think of a CRM tool, in the past it required a dedicated team to install and roll it out to an organization.  Now a small company can purchase Salesforce and have the same tool without worrying about who's going to reboot the server at 2am on Saturday morning.  Or patching the system when a new vulnerability comes out.

 

It's also moved software from IT to the business.  Business users need tools to get their jobs done.  In the past they would go to the IT department and try to describe what they needed, then IT would find the tool, figure out what's needed, purchase and implement.  Often somewhere between the request and implementation what the business wanted and what they received was vastly different.  SaaS has changed everything in the sense that the business can now find the tool they need, sign up online and start to use it.  They no longer need to go through IT to get it.

 

I know there's a lot of skepticism about SaaS from Wall Street.  Maybe it's justified, or maybe it's just a misunderstanding of what this stuff actually is. 

 

Maybe the best analogy is this.  Traditional IT purchasing is like having your brother-in-law's cousin purchase a car for you.  SaaS is having a lease where every time a new feature is rolled out the car company comes and replaces your car for no additional cost.  You might have a new car each month if models are released that quickly and it's exactly the car you want.

[KCLarkin]

I know there's a lot of skepticism about SaaS from Wall Street.  Maybe it's justified, or maybe it's just a misunderstanding of what this stuff actually is. 

 

The SaaS business model tends to be less attractive from a cash flow and accounting perspective. In the old days, you sold BigCo a new software license and paid your sales guy a big commission. The costs and revenue were both front loaded. With SaaS, you take the costs upfront and then recapture it over the life of the account. This makes a direct sales force less feasible.

[pks99]

FWIW - Some historical perspective on IBM's previous transformations may provide useful context.  Clayton Christensen has studied extensively the shift IBM made from mainframes to PCs in the 1970s and the shift IBM made from PCs to laptops in the 1990s. The shifts encompassed every part of the business and required incubating the new business away from the incumbent business.  IBM is one of the few companies that has successfully executed such a transformation, twice. 

 

An assumption investors seek to be making in IBM is that the company is capable of making another such transition (hosted software/hardware to SaaS/cloud) again in the next decade.  Few of the people at IBM from the 70s, 80s and 90s are around now (some like Rometty) but potentially the business model transformation legacy remains.

[intothebreach]

 

I have done some work last year so it is a bit dated. But here it goes.

 

http://vinodp.com/documents/investing/IBM%20Valuation%20-%20Vinod%2010-24-2013.pdf

 

 

Vinod, thanks for sharing the write up. IBM is not a stock I was following closely before the recent drop, so this was a very interesting primer.

[Eye4Valu]

I seem to recall WEB saying that one of the reasons he got comfortable with IBM was the recurring revenue stream from long term service contracts. Anyone able to shed some light on this?

[CorpRaider]

Are "cloud" and "software as a service" just some trendy tech consultant, venture capital, b.s. euphemisms for lease versus buy cap ex decisions?

 

Interesting perspective, I would disagree.  SaaS and cloud moves management from your network to someone else.  Features can be rolled out universally quicker, and adoption is easier because the software is platform independent.  The support cost is moved from your own company to someone else.

 

SaaS has enabled a lot of smaller companies access to software that wasn't available years ago.  Think of a CRM tool, in the past it required a dedicated team to install and roll it out to an organization.  Now a small company can purchase Salesforce and have the same tool without worrying about who's going to reboot the server at 2am on Saturday morning.  Or patching the system when a new vulnerability comes out.

 

It's also moved software from IT to the business.  Business users need tools to get their jobs done.  In the past they would go to the IT department and try to describe what they needed, then IT would find the tool, figure out what's needed, purchase and implement.  Often somewhere between the request and implementation what the business wanted and what they received was vastly different.  SaaS has changed everything in the sense that the business can now find the tool they need, sign up online and start to use it.  They no longer need to go through IT to get it.

 

I know there's a lot of skepticism about SaaS from Wall Street.  Maybe it's justified, or maybe it's just a misunderstanding of what this stuff actually is. 

 

Maybe the best analogy is this.  Traditional IT purchasing is like having your brother-in-law's cousin purchase a car for you.  SaaS is having a lease where every time a new feature is rolled out the car company comes and replaces your car for no additional cost.  You might have a new car each month if models are released that quickly and it's exactly the car you want.

 

Yeah, it was intended to be more of a question.  Thanks for your response.  I don't see how they don't make that margin up (and more) once they've got you locked in to their subscription model, unless it is truly (all of a sudden) a commodity product.  I mean if these are mission critical IT infrastructure investments that I'm currently (or recently) willing to spend millions and millions of dollars on rolling out and maintaining, it is just odd that that could be instantly replaced by a commodity subscription model where I can just force all of those costs onto to my IT/Software vendor and they just have to deal with that, because now it is a commodity and I can go get it from amazon or some other newbie.  And I just trust their reliability an security even given than if systems go down now I'm totally closed for business?  For a large company or enterprise, I don't know about outsourcing my critical systems to a subscription model.  Of course I can't see how I benefit by subscribing to microsoft office 365 versus buying a new license once every half a decade, if I've got scale and I need to develop the ability to keep stuff running in house anyways.  Now if I'm a three man law office, or a two guy app developer, yeah I suppose I can see it, but as a small fry I could never dream of having IBM anyways.  Also, if something goes really wrong I'd rather be suing IBM than workday or one of these other newbs, for sure.

 

Of course, I always thought contract manufacturing by the likes of Apple (and perhaps others who are even more dependent on the actual hardware) would sew the seeds of their destruction.  I make a product, so let me teach a low cost producer located in a jurisdiction without the rule of law to protect my IP how to manufacture it exactly to my specifications and I will work with them to perfect the production process.  That should work out well.  But I suppose if that design is obsolete in 6 months, there's not a problem.  I doubt BMW will be getting Flextronics to make their 3 series anytime soon.

[hyten1]

i don't see transition to cloud as something so monumental, from IBM perspective, comparing to what they have done in the past (transition from typewriter/biz machine ->mainframe (this was the oldschool "the cloud") -> PC/client server -> tech services etc).

 

now does it mean IBM are guarantee to succeed ... of course not.

 

cloud is hosted software/service. yes company doesn't need to pay for IT/hardware/consultant onsite etc etc., but they do have to pay for subscription, sometimes consultant too. The cloud is still software, not all software are as easy to use as your iphone. There still are setups, configuration, migration, lock in etc etc. and don't forget, "the subscription" payment in perpetuity.

 

The simplest cloud software is email (on one end of spectrum) there are other very complicated system.

[CorpRaider]

i don't see transition to cloud as something so monumental, from IBM perspective, comparing to what they have done in the past (transition from typewriter/biz machine ->mainframe (this was the oldschool "the cloud") -> PC/client server -> tech services etc).

 

now does it mean IBM are guarantee to succeed ... of course not.

 

cloud is hosted software/service. yes company doesn't need to pay for IT/hardware/consultant onsite etc etc., but they do have to pay for subscription, sometimes consultant too. The cloud is still software, not all software are as easy to use as your iphone. There still are setups, configuration, migration, lock in etc etc. and don't forget, "the subscription" payment in perpetuity.

 

The simplest cloud software is email (on one end of spectrum) there are other very complicated system.

 

Yeah it seems to me once the market normalizes,(perhaps once all of this new money from equity investors in start ups is pissed away) they're going to have you/their clients "by the short and curlies".  Yeah you didn't have to invest several million in the hardware and software, but then again you NEED me tomorrow to turn on the lights.  No more waiting for the next upgrade cycle and no more milking that 7 year old system that is good enough.  I don't understand how this is totally different than Flour analyzing whether to buy that equipment from CAT or rent it from Sunbelt, which is maybe more appropriate for the one at a time spec builder; other than someone saying "cloud" and doing the mind blown hand gesture.  Of course, I know exceedingly little about the world of enterprise IT and have no investments in the space.

[ERICOPOLY]

i don't see transition to cloud as something so monumental, from IBM perspective, comparing to what they have done in the past (transition from typewriter/biz machine ->mainframe (this was the oldschool "the cloud") -> PC/client server -> tech services etc).

 

True, but UCLA under John Wooden is not UCLA under Steve Alford.  Different players, different coach, different administrators, different fans.  But same uniform!

[oddballstocks]

Are "cloud" and "software as a service" just some trendy tech consultant, venture capital, b.s. euphemisms for lease versus buy cap ex decisions?

 

Interesting perspective, I would disagree.  SaaS and cloud moves management from your network to someone else.  Features can be rolled out universally quicker, and adoption is easier because the software is platform independent.  The support cost is moved from your own company to someone else.

 

SaaS has enabled a lot of smaller companies access to software that wasn't available years ago.  Think of a CRM tool, in the past it required a dedicated team to install and roll it out to an organization.  Now a small company can purchase Salesforce and have the same tool without worrying about who's going to reboot the server at 2am on Saturday morning.  Or patching the system when a new vulnerability comes out.

 

It's also moved software from IT to the business.  Business users need tools to get their jobs done.  In the past they would go to the IT department and try to describe what they needed, then IT would find the tool, figure out what's needed, purchase and implement.  Often somewhere between the request and implementation what the business wanted and what they received was vastly different.  SaaS has changed everything in the sense that the business can now find the tool they need, sign up online and start to use it.  They no longer need to go through IT to get it.

 

I know there's a lot of skepticism about SaaS from Wall Street.  Maybe it's justified, or maybe it's just a misunderstanding of what this stuff actually is. 

 

Maybe the best analogy is this.  Traditional IT purchasing is like having your brother-in-law's cousin purchase a car for you.  SaaS is having a lease where every time a new feature is rolled out the car company comes and replaces your car for no additional cost.  You might have a new car each month if models are released that quickly and it's exactly the car you want.

 

Yeah, it was intended to be more of a question.  Thanks for your response.  I don't see how they don't make that margin up (and more) once they've got you locked in to their subscription model, unless it is truly (all of a sudden) a commodity product.  I mean if these are mission critical IT infrastructure investments that I'm currently (or recently) willing to spend millions and millions of dollars on rolling out and maintaining, it is just odd that that could be instantly replaced by a commodity subscription model where I can just force all of those costs onto to my IT/Software vendor and they just have to deal with that, because now it is a commodity and I can go get it from amazon or some other newbie.  And I just trust their reliability an security even given than if systems go down now I'm totally closed for business?  For a large company or enterprise, I don't know about outsourcing my critical systems to a subscription model.  Of course I can't see how I benefit by subscribing to microsoft office 365 versus buying a new license once every half a decade, if I've got scale and I need to develop the ability to keep stuff running in house anyways.  Now if I'm a three man law office, or a two guy app developer, yeah I suppose I can see it, but as a small fry I could never dream of having IBM anyways.  Also, if something goes really wrong I'd rather be suing IBM than workday or one of these other newbs, for sure.

 

Of course, I always thought contract manufacturing by the likes of Apple (and perhaps others who are even more dependent on the actual hardware) would sew the seeds of their destruction.  I make a product, so let me teach a low cost producer located in a jurisdiction without the rule of law to protect my IP how to manufacture it exactly to my specifications and I will work with them to perfect the production process.  That should work out well.  But I suppose if that design is obsolete in 6 months, there's not a problem.  I doubt BMW will be getting Flextronics to make their 3 series anytime soon.

 

Good points, but I do think the model works. Look at the Bloomberg Terminal, possible the first SaaS. That thing is fundamental and vital to many funds and banks. A lot of shops route their trading through the terminal. If it goes down they are losing millions or more. The reliability of the Bloomberg is probably a lot higher than most corporate IT systems.

 

Funds are happily paying between $2-30k a month (depending on exchange data and features) per machine for software that lives somewhere else and is critical. Of course Bloomberg knows how mission critical their systems are and they are ready to sell you a dedicated circuit and specialty hardware so nothing breaks. Even their hardware is on a service contract. A user doesn't own the keyboard, it's rented. Spill coffee on it at 2am, no problem call their 24hr support and they'll next day a new one.

 

As consumers we are thinking about Office365 and $15/mo items. In the enterprise world there are some SaaS applications whose monthly prices would make Bloomberg blush.

 

Reliability is usually better with these things too. Consider AWS, if you need more machines it dynamically scales for you. To do that in a traditional environment requires the purchase if new servers, provisioning, setup and rollout. Not something that can happen in a few minutes. As for reliability I know Netflix has their entire infrastructure hosted in the cloud on Amazon. The amount of data they are hosting is incredible.

 

Now here's the catch, none of the cloud eliminates the people required to run this. You still need people to set things up and build it out. They aren't directly on the metal, but for larger companies the IT guys aren't usually running around in the data center either. So the cloud vs own data center makes no difference. But the benefits of outsourcing the hardware can be huge.

[kevin4u2]

If you read the annual report it says roughly 2/3rds of the service and software revenue is "annuity like".

 

I fail to understand why so many articles are obsessed with top line growth. IBM has had zero top line growth for ten years.

 

I also like how in some past quarterly reports, IBM revenue declines while "revenue per share" is actually increasing. Sometimes it takes an Eye4Valu to see the forest for the trees.

 

I seem to recall WEB saying that one of the reasons he got comfortable with IBM was the recurring revenue stream from long term service contracts. Anyone able to shed some light on this?

[CorpRaider]

I guess the fear is that some/many customers over time cancel those annuity contracts and start paying a monthly subscription to a "cloud" company? 

 

Thanks for all the information oddball.  I guess one could see the move to cloud as just further specialization.  Instead of say an automobile manufacturer building all this internal apparatus to create and support various IT systems, a company that specializes in building and maintaining that stuff does it for a subscription fee.  I guess like (as you point out) bloomberg specializing in building the analytical software and gathering the data, versus a user trying to do that internally with huge research and IT departments.  And basically bears would say IBM didn't see this coming and didn't position itself for the change.

[KCLarkin]

And basically bears would say IBM didn't see this coming and didn't position itself for the change.

 

In Who Says Elephants Can't Dance, Gerstner predicted cloud would be the next transformation. This was in 2002. It was easy to see what was coming but pretty hard to predict when.

[LowIQinvestor]

For those that think IBM is some old stodgy company that sells buggy whips, why would Apple partner with them?

 

Read the transcript (Apple CEO Tim Cook and IBM Chairman & CEO Virginia Rometty):

http://www.cnbc.com/id/101839103

 

Here is Apple's press release on the partnership:

http://www.apple.com/pr/library/2014/07/15Apple-and-IBM-Forge-Global-Partnership-to-Transform-Enterprise-Mobility.html

 

 

"“iPhone and iPad are the best mobile devices in the world and have transformed the way people work with over 98 percent of the Fortune 500 and over 92 percent of the Global 500 using iOS devices in their business today,” said Tim Cook, Apple’s CEO. “For the first time ever we’re putting IBM’s renowned big data analytics at iOS users’ fingertips, which opens up a large market opportunity for Apple. This is a radical step for enterprise and something that only Apple and IBM can deliver.”

 

[KCLarkin]

Then they acquire a company such as Salesforce.  Fast forward 5-10 years and the new IBM doesn't look like the current one at all.  The merger brings new life into the brand and changes the direction of the company.

 

Salesforce.com doesn't make any sense for IBM. Too big. Wrong target market. Wrong business model.

 

IBM has the right strategy. Mark Cuban (derisively) calls it merger arbitrage. They can buy a startup for $1B, slap the IBM name on it and push it through their enterprise salesforce and turn it into a $1B/year company. The brand name and distribution creates enormous value. The problem is that the legacy, low-growth business is so large relative to the merger arbitrage opportunities. They need to remix towards higher value and higher growth while managing their declining businesses. Not an easy balancing act.

 

The real worry with IBM is execution. With 400,000 employess, it is slow and complex. And with the constant "transformations", there is a real risk to employee morale and company culture.

[Vish_ram]

Also the key to understanding IBM's moat is that many of their products have logic and data. The logic can be tweaked for a given client (custom built). Both are embedded into the customer's business process. It makes migration to a new vendor harder. The moat remains even when the whole software is moved from client's server to cloud.

 

Think of an accountant using excel with all custom formulas (logic) and data (linked to access, and other systems). It is a pain to move away from this ecosystem. Win OS may get replaced, but excel may continue to live on.

 

If you read the annual report it says roughly 2/3rds of the service and software revenue is "annuity like".

 

I fail to understand why so many articles are obsessed with top line growth. IBM has had zero top line growth for ten years.

 

I also like how in some past quarterly reports, IBM revenue declines while "revenue per share" is actually increasing. Sometimes it takes an Eye4Valu to see the forest for the trees.

 

I seem to recall WEB saying that one of the reasons he got comfortable with IBM was the recurring revenue stream from long term service contracts. Anyone able to shed some light on this?

[A_Hamilton]

Then they acquire a company such as Salesforce.  Fast forward 5-10 years and the new IBM doesn't look like the current one at all.  The merger brings new life into the brand and changes the direction of the company.

 

IBM has the right strategy. Mark Cuban (derisively) calls it merger arbitrage. They can buy a startup for $1B, slap the IBM name on it and push it through their enterprise salesforce and turn it into a $1B/year company. The brand name and distribution creates enormous value. The problem is that the legacy, low-growth business is so large relative to the merger arbitrage opportunities. They need to remix towards higher value and higher growth while managing their declining businesses. Not an easy balancing act.

 

 

This is so 2000 and late. Have you looked at the multiples on cloud names today? The price of companies with $0 in day one revenue is stratospheric. IBM has underinvested in R&D and Capex for the last 7 years thinking that the strategy that worked for them from 2000-2007 (acquiring revenues) would continue to work regardless of market valuation.

 

Now they are behind. Look at what Nadella said the other day $4-$5 billion in Capex (Not R&D, Capex!) on cloud buildout this year at MSFT and many years into the future. IBM cloud capex...$1 billion have been spent in total.

 

MSFT's R&D is 15% of revenue, what's IBM 5%? Now they'll claim they do acquisitions to get to 10% of revenue...but competitors are doing this too.

 

 

 

[KCLarkin]

This is so 2000 and late. Have you looked at the multiples on cloud names today? The price of companies with $0 in day one revenue is stratospheric.

 

How many companies on this list have you ever heard of?

http://en.wikipedia.org/wiki/List_of_mergers_and_acquisitions_by_IBM#Acquisitions_since_2000

 

MSFT's R&D is 15% of revenue, what's IBM 5%?

 

What is MSFT's return on that investment? What is Accenture's R&D budget?

[Palantir]

For those that think IBM is some old stodgy company that sells buggy whips, why would Apple partner with them?

 

 

"“iPhone and iPad are the best mobile devices in the world and have transformed the way people work with over 98 percent of the Fortune 500 and over 92 percent of the Global 500 using iOS devices in their business today,” said Tim Cook, Apple’s CEO. “For the first time ever we’re putting IBM’s renowned big data analytics at iOS users’ fingertips, which opens up a large market opportunity for Apple. This is a radical step for enterprise and something that only Apple and IBM can deliver.”

 

Apple is simply using IBM as their institutional salesforce.

[vinod1]

Whether a particular system can be outsourced or run on the cloud is not really the key. It is better to look at a system from a competitive advantage/core competence perspective of the individual companies. Even critical systems like Bloomberg can be fully outsourced as it is not a source of competitive advantage for any company. On the other hand some systems are absolutely core to the company's strategy and these systems would never be commoditized and these would not be bought from a vendor offering it on the cloud to everyone. Example would be credit scoring/decisioning systems for banks. IBM would do very well in this space for a long time. These might be run on a private cloud or whatever but it does not impact IBM all that much.

 

In addition, there is lot of application integration work where you need to tie together several different systems. Example would be providing a single view of the customer for say banks for their various products. IBM would be doing just fine in this as well for a long time. So the threat of cloud is way overblown for IBM.

 

Vinod

 

 

 

 

 

 

 

 

[vinod1]

IBM acquiring salesforce would be similar to HP's acquisition of Autonomy. An unmitigated disaster. The history of large acquisitions where companies paid 10x sales, as IBM must to acquire salesforce, makes this as close to investment certanity as you can get.

 

"If you want to destroy value quickly, there's not a process that does it better than acquisitions." -Damodaran

 

Vinod