IBM Is Making the Right Moves

Alexander is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

IBM (NYSE: IBM) recently reported that workforce re-balancing will cost the company $1 billion. The company is hoping to cut down on the size of its labor force in the systems technology group. The segment will reduce its size by 121 employees. The company is hoping to grow its business by focusing on hybrid-cloud technologies and cutting costs in non-performing segments.   

Changing landscape is hurting IBM

The competitive landscape has been foreboding to IBM. However, the hoped for outcome is restructuring in the systems technology group in order to increase the amount of revenue. Likewise, the company will be growing the revenues in its cloud division. The problem is that the growth in the cloud segment is unlikely to make up for the significant decline in sales from systems technology. The systems technology group reported a 17% decline in revenues year-over-year.

IBM will have to compete with companies like Hewlett-Packard (NYSE: HPQ), Amazon (NASDAQ: AMZN), and Microsoft. Hewlett-Packard could under-cut major competitors within the space and is heavily focused on process-driven initiatives in order to increase efficiency. The company is developing solutions in anticipation of unique problems and will be rolling out cloud solutions. Hewlett-Packard isn’t the only problem though. Amazon is notorious for being ridiculously competitive in cloud virtualization. Amazon is by far and away IBM’s biggest threat. Unlike Hewlett-Packard, Amazon doesn’t have to balance the needs of other IT businesses as Amazon is heavily diversified and generates significant revenues from retail within the United States and internationally. Amazon isn’t at risk of cannibalizing any of its existing businesses.

Meg Whitman in a recent interview reiterated the strength of Hewlett-Packard’s core assets. She also stated that consumers of Hewlett-Packard want to see Hewlett-Packard win because Hewlett-Packard has a strong brand presence in the enterprise computing space and has very fair pricing practices. Meg Whitman believes that Hewlett-Packard will generate revenue growth in 2014.

IBM turnaround

I believe that IBM will stem the decline in revenue growth prior to 2015. The company believes that it will generate at least $20 in earnings per share. The company’s EPS growth will be driven by a mix of share buybacks, emphasis on software (which will represent a greater percentage of profit), and $20 billion in acquisitions. The company currently generates $14.50 per share; so the company’s guidance to earn $20 per share is what’s keeping investors on board.

Chances are high that the company will cut costs in its systems technology segment at a faster rate than the rate at which revenues decline. This strategy will meet its long-term earnings per share target. The company will then acquire companies for intellectual propertyand customers, in order to maximize net income. The acquisitions will include cloud companies or companies in big data.

Following that, the share buybacks will help to inflate the EPS figure (the company plans to return $70 billion to shareholders by 2015; the company’s market capitalization is $223 billion). While I am slightly concerned by the company’s system technology segment, I believe that the company’s earnings growth will continue as planned.

Other investment opportunities

Hewlett-Packard could be a compelling investment opportunity. The company’s computer business should eventually stabilize by 2014. Meg Whitman anticipates that because Windows XP support will end in Q1 2014 that there will be pent-up demand in the enterprise market. Currently 40% of businesses still use Windows XP, so we could see a substantial amount of growth in desktop and laptop computer sales. IDC also forecasts that international demand will offset the decline in US computer demand. International laptop PC sales are projected to grow by 3.9% in 2014; according to IDC this will offset the decline in domestic computing demand.

Hewlett-Packard is currently heavily focused on cutting down on its head count and is more focused on improving business processes in order to generate higher rates of profitability from its PC business. So far the company seems to be succeeding, and analysts anticipate the company growing its earnings from $0.31 per share in 2012 to $3.57 per share in 2013. The company has been able to stabilize its operations in 2012, going from near break-even to reasonable profitability in 2013.

Amazon is a also a compelling investment opportunity. The company is expanding its retail footprint internationally, which was hit by some trouble in consumer sentiment in European markets. The company has built out retail distribution infrastructure throughout Europe, Asia-Pacific, and South America. I believe the company’s revenue growth will improve from the 16% it reported in its latest quarter. The company’s spending on property and equipment has gone up by 114% per year, implying that the company’s management team has been able to identify and eagerly execute upon growth opportunities.

I think it would be wise to stay the course with Amazon. The company’s growth in international markets is somewhat bottle-necked due to issues with Internet saturation, a lack of merchant platforms in certain markets, and global economic sentiment. All of these factors are temporary, meaning that the company could surprise on cash flow, revenue, and net income growth in future accounting periods. Going forward analysts expect Amazon to generate 37.15% in earnings growth on average over the next five years.

Conclusion

I think IBM is on the right track, and the company should be able to meet its $20 earnings per share target. This may involve declines in revenue growth from the systems technology group. But this might be a good thing; perhaps the cloud and IBM’s range of software, services, and data solutions will have a higher contribution to net income, and a lower contribution to revenue. I am doubtful that analysts would punish IBM's growth in net income, even if it involves a minor sacrifice on top-line revenues.

Technology can be a volatile place, but I believe Hewlett-Packard and Amazon should be included in a technology portfolio. In addition to the potential increase in returns on investment, this could offset some of the risk associated with IBM.

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Alexander Cho has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com and International Business Machines.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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