A lot has been written about International Business Machine’s (NYSE:IBM) current woes and why the stock will supposedly keep trending downward. Apart from the usual reasoning that the company’s declining profits over the past 14 quarters signifies something inherently wrong with its fundamentals, a new thesis is emerging. Before we examine this new thesis, which I believes holds no water, here are a couple of things that I think anyone planning to put money into IBM should be aware of.
First, revenue for the third quarter declined 14 percent year-over-year and the company reduced its earnings guidance for the full year. What’s worse is that the declines in revenue seem to be accelerating and IBM now expects EPS of $15.75 at most by the year end. There is already plenty of analysis on IBM’s third quarter so I won’t be going into it in great detail. However, one thing that I believe is worth mentioning is that a great deal of the analysts covering the company have grossly underestimated the effect of the company’s currency exposure.
According to last year’s annual report, IBM received about 45 percent of its revenue from America with the rest coming in from Europe, Asia Pacific, Middle East and Africa. Over the past year, the U.S dollar has considerably strengthened against these regions’ currencies translating to less revenue earned for IBM. For example, the euro has declined by about 21 percent versus the dollar and it is expected that this trend is likely continue as the European Central Bank has hinted about plans to start its quantitative easing program.
Moreover, should the Fed hike interest rates this coming December the probability of the dollar reaching parity with the euro by next year is almost be assured. This means that Big Blue will be facing even tougher times ahead. In spite of this, a closer examination reveals that IBM’s revenue from Europe, Middle East and Africa region, adjusted for currency actually grew by 1 percent. So overall, I wouldn’t be too quick to write off the company as a failing business.
So what’s the new threat?
Both Oracle (NYSE:ORCL) and Intel (NASDAQ:INTC) recently launched massive cloud computing data centers that would be used to test Oracle servers running on Intel chips in a project dubbed Apollo. With the conclusion of the testing phase, the two are now ready to start selling to enterprise customers, which effectively puts them in direct competition with IBM.
While it’s widely considered that Intel holds a near monopoly in the data center space with its industry standard Xeon processors, the high-end server and mainframe market has largely been IBM’s domain and it is this new partnership that is spooking investors. In a recent presentation at Oracle World in San Francisco, Oracle CEO Mark Hurd pointed out that thousands of customers were still using “large and costly” IBM systems.
Mark also claimed that the new architecture would offer better performance than IBM’s systems at a fraction of the cost and to prove his claim, he revealed that Oracle would be offering qualifying Power System customers with a free, non-disruptive proof-of-concept migration to demonstrate the difference.
Why there is nothing to fear
In reality, this development need not get investors worried and here is why. IBM’s mainframes still offer all the components (ability to virtualize workloads, plenty of memory and storage space) needed to run a private cloud ecosystem. Additionally, many enterprises are already running their business applications on a mainframe, which means that rewriting them for cloud compatibility is likely to present a significant challenge.
According to WIRED, 96 of the world’s top 100 banks and about 90 percent of the world’s top insurance firms still depend on mainframes due to their reliability, predictability and scalable characteristics. Mainframes still offer better control over workloads and in terms of managing vector processing mid-range systems come nowhere close in comparison.
The IBM z13 mainframe for instance is the world’s first system with the capability of processing 2.5 billion transactions on a daily basis and it also offers the ability to encrypt mobile transactions in real-time. “We’re driving toward a world where more and more people are using mobile devices, or embedded devices, to interact with systems,” John Birtles, director of IBM z Systems, told WIRED. “We need to make sure that those devices are secure, that the transaction’s secure, and that our clients get the level of analytics that gives them opportunities to improve their businesses.”
Ultimately, enterprise customers are not only looking for cost-saving solutions, but also security of their data and information. The Oracle and Intel systems are unproven in this regard and in my opinion getting the large enterprise customers to shift to these systems will not happen anytime soon.
To further illustrate the significance of IBM’s mainframes, revenue from z systems mainframes was up 15 percent in the quarter at a time that the general consensus was that fridge-sized mainframes were on their deathbed.
IBM may be in some troubled waters for now, but one thing remains clear. The company’s high-end sever and mainframe business is not facing a serious threat from the Oracle-Intel duo as it will take a great deal to get major enterprise customers to overhaul their ecosystems. All in all, I believe IBM is a great business and that its biggest problem is currency issues, not the partnership between Oracle and Intel.