This Old Dog Can Learn New Tricks

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

It may have seemed hard to believe a decade ago, but looking at the tech industry today, it appears that the old hardware companies are on their last legs, as cloud computing becomes a more important factor in the stability of companies. In addition, cloud software is vital for businesses that need to share and access information in an efficient, inexpensive, and cooperative manner. So, how do hardware companies transform into software and cloud-based companies?

IBM (NYSE: IBM) may have the answer. Contrary to others in the industry, specifically Accenture (NYSE: ACN) and Oracle (NYSE: ORCL), IBM actually reported positive growth last quarter, on the heels of investments in cloud computing and software, beating analyst estimates with a $3.91 per share profit. Even better for IBM, the company is projected to ring in profits to the tune of $16.90 per share for the year, ahead of the estimated $16.70 per share originally forecasted, a 1.6% increase year-over-year.

Making the reports look good while renovating

The reason for this uptick is due to IBM’s strategy of generating returns for stockholders by boosting dividends and share buybacks, while the company undergoes a $1 billion restructuring. To defer the costs during this restructuring, IBM has cut over 3,300 jobs in the United States and Canada, rather than scaling back dividend payouts. This is actually a good strategy because, in the middle of a five-year restructuring, you want to keep investors on your side. Not only does this keep earnings reports looking pretty good, despite a 3.3% year-over-year drop in revenue, it also allows IBM to shed weight in “low-margin” areas like IT and the hardware sections of the economy, which speeds up the process of restructuring into a more modern company.

Accenture not keeping up with IBM

IBM’s approach has, thus far, yielded positive results in the eyes of the investment community, but its main competitor, Accenture, hasn’t taken steps in that direction and has taken a hit because of it. Like IBM, IT services have been Accenture’s main problem, and communications software has declined 3% for the quarter. Company officials maintain that this is due to customers not going for short term commitments like they used to, opting instead for long-term options when dealing with Accenture. In terms of earnings, this has resulted in the company taking a hit with investors, as there aren’t enough efforts being devoted to keeping investors, should there be a need to make an aggressive cloud push (which is not far off). Like IBM, Accenture would benefit from examining its hardware and short-term offerings to determine where cuts can be made in an attempt to drive down costs without spooking investors. Yet, there has been little Accenture has put out for investors regarding a feasible shift to cloud software, in place of IT software.

Oracle’s slump shows difficulty in adapting

Accenture offers a strong range of cloud computing packages for sale, but unlike IBM, the company hasn’t set about creating a road map for the future of the company, which would involve going away from hardware. Oracle, on the other hand, has attempted to stay in the game by teaming up with smaller cloud software companies like Salesforce.com to share data and expand its presence in cloud computing. After two straight quarters of declining profits and revenue, the push by Oracle to acquire cloud data software is a much-needed commitment for the old hardware giant of yesteryear. Yet, like Accenture, there hasn’t been word of a downsizing of its hardware division. In fact, Oracle has been attempting to tell the world that it's still a relevant company and the surge of upstart cloud computing companies is overstated. This doesn’t present a good business strategy for Oracle, and if it can’t slim down, there may be trouble ahead.

The bottom line

Of these three companies, IBM seems to be the only one that has made the effort to modernize in a push to stay competitive. It’s Five Year Plan of investment in fast-growing markets like cloud software, $3.6 billion in share buybacks, cutting jobs and costs in a shrinking hardware market, and a $1 billion restructuring (at little cost to stockholders) is so far proving to be a success. The ultimate success will be hitting the target of 50% of profits coming from software, which is more forward-looking than sticking to hardware sales, which made up 14% of profits in 2012, down from 35% of profits in 2000. Dividends have increased to $0.95 per share last quarter, up from $0.55 per share in 2010, so investors are reaping the rewards of IBM’s “shareholder first” reboot strategy.

With a forward P/E of 10.7 and a P/B of 12, IBM represents a pretty cheap buy that has a lot of room for growth. Thanks to a profit margin of over 15% and operating margin of over 20%, the company has some breathing room to implement its five-year plan at little damage to the stock price or to investor's portfolios. Accenture, meanwhile, has a higher P/E at 16.6 and a lower P/B ratio at 8.8, easily making it a less worthwhile investment than IBM, aside from a higher annual dividend yield.

This will encourage investors to keep IBM in their portfolios, and gives assurance that this old dog can still learn new tricks. 

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John McKenna has no position in any stocks mentioned. The Motley Fool recommends Accenture. The Motley Fool owns shares of International Business Machines. and Oracle.. 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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