Saturday 20 July 2019

Future of sleeping giant IBM remains cloudy, despite move

Deal puts IBM into cloud market - facing Amazon and Google

IBM ceo Ginni Rometty. Photo: REUTERS/Steve Marcus
IBM ceo Ginni Rometty. Photo: REUTERS/Steve Marcus

John Lynch

One of my favourite characters in literature is Rip Van Winkle, the man who fell asleep and didn't wake up for 20 years.

The world of business has changed so completely over the last few decades that I fancy if Rip Van Winkle woke up this morning, the poor man would want to go straight back to bed. Perhaps the biggest surprise he would get can be summarised in three letters, IBM, the company we are looking at today.

At one time, IBM dominated the technology scene.

It was miles ahead of everyone; it was even constructing machines to take on and beat the great chess masters of the world.

It was at the front end of most of the great innovations, including the personal computer.

But, this morning, Rip Van Winkle would discover that these are past glories. If he rushed to check the business pages, he'd learn that IBM's present market value is $109bn (€95bn), while that of Microsoft - which IBM helped set up - is $802bn.

Thirty years ago, few big companies or governments were not IBM clients. It was basking in the warm glow of having invented the pieces of kit that changed life for so many, including the ATM and the point-of-sales scanner, that game-changer for the retail sector. Interestingly, Wrigley's chewing gum was the first product scanned.

But if our sleepy friend Mr Van Winkle was to tease out what IBM is famous for in 2019, he'd find it is the purchase of software group Red Hat for $34bn, the biggest deal in its 107 year history. It is also the largest ever software acquisition and described as 'transformative' because it is about breaking the trend of its declining revenues. And old Van Winkle would have trouble getting his head around that because he slept through the years when IBM seemed to lose its infallibility.

Since its prime, IBM has done one thing well. It has been adept at shuffling its tech portfolio to keep up to date with changing technology.

Over 25 years ago, it entered the software business by buying Lotus Computing, and seven years later it acquired PWC Consulting division.

In the early part of the century it exited the computer hardware business entirely by selling its PC and server business to the Chinese company Lenovo.

Four years ago, it offloaded its semiconductor business but retained its design capability.

The deal with Red Hat appears logical and makes IBM a contender in cloud computing, but this is a market dominated by Amazon and Google. This acquisition is welcomed by investors as the company has been contracting for many years.

Unfortunately, its much-hyped Watson AI technology has failed to compensate for the fall in its traditional IT business. It has also been ineffective as the company was outstripped by Amazon and others in cloud technology. However, by combining its cloud business (revenues $20bn) with Red Hat could give IBM a competitive edge, but it does not come cheap and the task of integrating both companies could be challenging.

It has been a long and challenging road for a group that started out making meat slicers and weighing machines. Unfortunately, in the last seven years, the group appears to have lost its way. Global revenues fell $28bn to $79bn, net profits plunged from $16bn to $5.7bn and profit margins at 7pc have halved.

It is no surprise that the famous investor Warren Buffett abandoned ship early last year.

The Red Hat acquisition is a major gamble for IBM and its CEO Ginni Rometti. While she has maintained a financial strategy that rewards shareholders with dividends and buybacks, to fund the Red Hat deal, the group now needs to borrow heavily at a time of increasing interest rates and will probably suspend its share buyback programme.

Will the acquisition usher in a new era for Big Blue?

There are still plenty of admirers of IBM's rich history and innovation but tomorrow's earnings are what matters. With a price earnings multiple down to eight, it might just be worth a flutter.

Nothing in this section should be taken as a recommendation, either explicit or implicit to buy any of the shares mentioned.

Irish Independent

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