201401.22
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IBM As A Service Proxy

When you think of business investment, far more often than not the typical reaction is something like heavy equipment at an industrial firm. While that is certainly an important aspect of overall productive growth, with firms like General Electric representing the industrial investment, in this more service oriented economy it is computer and technology spending that represents business investment. As a global leader, IBM is near-king in providing products for service sector investing.

Like General Electric, IBM’s results defy the narrative that businesses are seeing a positive turnaround, and further that the economy is progressing on a better trajectory more recently. And there is not a trace of QE anywhere, defying that monetary policy has created a climate which is conducive to business investment (other than inventory, of course). If GE and IBM are at all proxies, and I certainly believe as much, then the economy in terms of business investment is reacting very much like consumer spending and the retail segment.

Looking at IBM’s chronology of revenue growth, it is clear that the company saw a tremendous slowdown in the early part of 2012 from which is has not recovered. That is certainly a proxy for the economy as this pattern is replicated over and over, not just in individual company results but even in the statistically adjusted government numbers.

ABOOK Jan 2014 IBM History

Further, while the Great Recession saw a much deeper contraction in revenue, it was limited to only four quarters in duration. Going back to the second quarter of 2012, IBM has experienced top line contraction for now seven consecutive quarters; only missing eight because Q1 2012 was 0%.

As a global company, IBM’s results are not simply reflective of the US economy. Thus it is seemingly easy to separate the company’s struggles from that of the domestic economy, particularly with Europe such a healthy proportion of revenue generation. But in 2013, full-year revenues from Europe were actually flat over full-year 2012. And while Asia-Pacific revenues tanked 12% in 2013, the largest share of IBM’s products was sold in the Americas where revenues fell 3%. That more than suggests that businesses in the service economy in the US are reluctant to invest in critical systems and the management of them.

Unlike Intel and the PC business that has a convenient (and relevant) excuse in tablets and mobile technology, this is pure business investment here. What is perhaps really concerning is that IBM’s hardware unit suffered -26% sales in Q4 2013 over Q4 2012. Software revenues were slightly positive but services revenue fell 4%. It hardly sounds like a robust business spending environment, not just in the US but across the globe – at a pace that is far more recessionary than not.

ABOOK Jan 2014 IBM Comps

For the full calendar year of 2013, free cash flow for IBM actually declined $3.2 billion to $15 billion. That would suggest an even greater emphasis on the cost structure heading into 2014, particularly since the company paid $4.1 billion in dividends and repurchased an astounding $13.9 billion in shares. Expect further headcount reduction, rather than any new hiring (sorry, Chairman Yellen, you’ll have to “work” that much harder). Of course, IBM may continue to saddle its future operations with additional debt to pay for its heavy emphasis on financial investment (+$3.4 billion, not including financing segment debt).

For the $18 billion spent on returning funds to shareholders, the company managed -5% in revenue, -1% in net income but at least EPS was positive at 4% (which was the worst annual growth rate since 2009). Once again, no recovery narrative here, only a representation of just how QE infects the economic system with distorted incentives that actually work against the economy.

I still fail to see how this all could be possible in a growing, recovery-like economy.  It would at least be plausible were IBM and GE, among so many others, on their way to being replaced by smaller and more innovative competitors.  But that is just not the case, there’s is not an idiosyncratic story here. It is a macro story of malfeasance at the highest levels.


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