IBM Update: Short on Financial Objectives, Long on Technology Dreams
IBM CEO Virginia Rometty earned just 55 percent of her total target compensation in 2015, according to the company’s proxy statement released March 7. That figure pretty much sums up IBM’s financial performance for the year as well.
This is the second year of a multiyear company transformation led by Rometty, who joined IBM in 1981 and became CEO in 2012. Her plan to refocus IBM for a better future is long on talk about exciting new technologies and short on specific financial targets and goals.
At an investor conference in February, 2016, for example, IBM
executives presented hours of information about cool
technologies they believe will drive the company’s future. Often
absent from those presentations were facts on market size,
competitive advantage, profitability, and demand related to the technologies. Little information was provided on the specifics of how these individual technologies would affect the financial dynamics of IBM.
At the same conference, CFO Martin J. Schroeter said that annual revenue growth would be 1 percent to 3 percent going forward, but didn’t highlight other financial expectations. On the subject of margins, for example, Schroeter made statements such as “We’ll have better margins, where we’re going.”
This kind of lack of specificity makes us wonder if Rometty has a grasp of where these technologies will take IBM. And without clear targets, it’s difficult for investors to see how much real progress is being made.
Rometty’s plan is to move IBM away from hardware, and other legacy products, and concentrate on becoming a cognitive solutions and cloud platform company with a focus on their so-called strategic imperatives of analytics, cloud, mobile, social, and security products and services. What we do know is that the expense involved in this transformation is affecting IBM’s short-term performance. For example, Rometty spent about $6 billion on acquisitions in the past seven months alone to facility the transformation. But in 2015, excluding divested businesses, total revenue fell 1 percent to $81.7 billion in constant currency from the year earlier, the second consecutive yearly decline. Operating net income dropped 12 percent. With only a few exceptions, sales and operating margins declined on a segment basis, although currency translations affected those results.
Revenue from strategic imperatives increased by 26 percent in 2015 and now represent about 35 percent of IBM’s total business. That’s up from 22 percent in 2013. In response to an analyst question on Investor Day, we learned that strategic imperatives might become 50 percent of sales by the end of 2016. We were told by CFO Schroeter not to expect a 26 percent growth
rate for strategic imperatives over time, but he gave no indication of what to expect instead.
Compensation Update: IBM’s total return is down by 29 percent during Rometty’s tenure even as her pay increased .28 percent during that time. Her total compensation was $19.8 million in 2015. The board made no changes to her base salary, target annual incentive, or annual long- term incentive award for 2016.
In the past, we’ve been concerned that IBM has used financial engineering to reach performance targets, which are based on: strategic imperative revenue, operating net income, operating EPS, free cash flow, and operating cash flow. IBM’s highly experienced board of directors has put a kibosh on some of those financial engineering tactics. For example, with the Performance Share Unit awards, beginning in 2016, the board has determined that actual operating EPS will be adjusted to remove the impact of share repurchases.
On the other hand, based on a variety of unnamed factors, the board has lowered the score needed to reach financial targets for the Annual Incentive Program. This might prevent Rometty from the embarrassment of failing to make next year’s targets. Unlike many public companies, IBM does not disclose its targets citing competitive reasons.
Capital Allocation Update: Rometty and Schroeter have managed to keep increasing the dividend and repurchasing of shares even as they’ve plowed back money into the business to facilitate its transformation. IBM had free cash flow of $13.1 billion in 2015, while investing 6 percent of revenue on research and development and announcing 15 acquisitions. They’ve paid out nearly $5 billion in dividends in 2015. They used $4.6 billion to buy back stock. However, that’s a 66 percent reduction from the amount used for share repurchases in 2014. They recently spent nearly $1 billion to expand their cloud data center footprint, now making IBM the world’s largest provider of cloud services.
IBM has invested about $27 billion in 130 acquisitions in the past 10 years. They’ve spent $4 billion on four healthcare companies in the past 11 months and recently made seven cloud- related acquisitions.
But the lack of transparency makes it difficult for investors to determine how much real progress is being made in terms of the successful integration of these purchases. And we’re often unable to determine the benefit of these acquired technology; whether they are worth the money invested in them, and if they can be used synergistically across the company or will sit in silos serving only pockets of the industry.
Management Update: IBM in the past six months has named three new managers to important businesses. David Kenny, former CEO of the Weather Company is the leader of Watson. Deborah DiSanzo joins the Watson healthcare business. She was CEO of Philips Healthcare. Harriet Green, CEO of the Thomas Cook Group, is running the IOT platform.
Change in Reporting: IBM beginning in April 2016 is making a significant change in the way it
reports segment results to better reflect its new business model. In March, it published 2014 and 2015 results in this new reporting method for comparison purposes.
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