Mad Dog 21/21: Groundhog Days
February 23, 2015 Hesh Wiener
On February 2 each year, in Punxsutawney, Pennsylvania, a groundhog predicts the duration of winter. If the woodchuck, awakened by handlers, sees its shadow, winter will last six more weeks. But if the animal casts no shadow, winter will soon give way to spring. Shortly before February 2, after three years of financial winter, IBM’s executive handlers elevated CEO Ginny Rometty’s remuneration by $3.6 million, calling the boost a performance bonus. I wonder what aspect of Rometty’s performance was so amply rewarded. IBM reported dismal quarterly results ending yet another year of financial decline.
Notwithstanding the apparent optimism of IBM’s board-level compensation committee, the company’s future may be no more certain than that of celebrity groundhogs. The woodchucks in Punxsutawney seem to be getting by, but their fellow marmots living elsewhere have failed to do as well.
In New York City, the mayor used to meet with a groundhog living at the Staten Island Zoo on its special day. Six years ago, in 2009, Michael Bloomberg, by far the wealthiest mayor in New York history, picked up a grumpy groundhog named Charles G. Hogg, which promptly bit him. Bloomberg is 5 feet 6, weighs less than 150 pounds and has a net worth north of $30 billion or $200 million a pound. If Chuck the groundhog managed to nip off even a small piece of Bloomberg’s finger, it would have had the most valuable snack in woodchuck history.
Five years after the Bloomberg groundhog incident, the February 2 ceremony fell to the Big Apple’s new mayor, Bill de Blasio. de Blasio is much larger than Bloomberg. He is about 6 feet 5 inches tall and weighs around 225 pounds. But when it comes to groundhogs, what he lacks in bravery he makes up in clumsiness. On Groundhog Day last year, he was given a female groundhog, gentle Charlotte, instead of the presumably more aggressive male that had bitten Bloomberg. Even so, de Blasio wore heavy leather gloves, gloves so stiff that they prevented the mayor from securely holding the little groundhog. de Blasio may have squeezed Charlotte pretty hard but that didn’t secure the creature, which wriggled out of his hands and fell to the ground. Shortly afterward, Charlotte died from unspecified internal injuries.
In 2015, the groundhog and mayor were separated. The star rodent was presented to the public in a clear cage. de Blasio, standing nearby, was not as well protected as the groundhog. Observers who had wished and dreamed that a giant woodchuck would reach down from the heavens and give the major a good shaking were disappointed. They had to settle for a brief and boring statement by New York’s groundhog-slayer-in-chief, that klutz de Blasio.
Like the late Charlotte in the mittened mitts of Bill de Blasio, IBM could well be dropped and killed by well praised and amply rewarded Ginny Rometty. But, so far at least, shareholders and the financial analysts that coo to them, among them Warren Buffett, who is worth twice as much as Michael Bloomberg, have bet that IBM will not merely survive but very likely return to growth. In fact, he Buffett has just increased his stake in Big Blue.
Are they nuts?
This is a question worth thinking about if one happens to have placed a bet on IBM that is big enough to reshape one’s life, or at least the financial aspects of it. Gambling bigtime on IBM is something career employees and quite a few investors have done. They apparently see in the future something that doesn’t at all resemble the immediate past.
In 2014 IBM’s fourth quarter, the most important three-month period year after year, brought revenue that, at $24 billion, was 12 percent lower than the same period in 2013. For the full year, IBM’s revenue fell by 6 percent to $93 billion. The company’s share price declined about 14 percent. This is the year for which Ginny Rometty was paid $1.6 million plus a $3.6 million as a performance bonus. (Designating the extra remuneration as a performance bonus makes it a tax deductible expense for IBM; ordinary pay in excess of $1 million a year is usually not able to be used as a deduction to offset corporate earnings.) Rometty also got stock options or warrants that, when fully vested in the fullness of time, could add more than $13 million to her take for the year.
When IBM’s results are broken down by business segments, the details add depth to the portrait of the company’s situation. Revenue from each of IBM’s two services segments fell 8 percent. Together, the two segments under which IBM manages its services operations accounted for $13.5 billion, more than half the quarter’s total intake. This shrinking half of IBM’s total business was the price of Lou Gerstner, who is said to have saved IBM from collapse by moving the company into services, thereby absorbing within IBM the funds customers had been spending on in-house systems and applications development and support along with a big chunk of what had formerly been end users’ operations groups. IBM built up its services staff offshore, mainly in India where it found it could attract some of that country’s best and brightest people, thereby reducing its costs without sacrificing quality.
But these days it looks like the services venture has passed its peak, as computing moves to its next phase, evolving from outsourcing to the cloud. For all of 2014, IBM’s services revenue fell by about 3.5 percent to $57 billion. Software, which at $7.6 billion brought in a bit more than half as much revenue as services during the most recent quarter, yields gross profit of 90 percent, an outstanding figure. Still, Big Blue’s intake from software fell 7 percent in the fourth quarter and nearly 2 percent for the year as a whole. IBM software is overwhelmingly sold to users of IBM hardware, so it is hard to see how the company can boost its software revenue while its hardware business is in full retreat and its installed base faces erosion as customers move from in-house glass houses to off-site services and ultimately to the cloud.
It is not surprising, then, that during the last quarter of 2014 IBM’s $2.4 billion hardware business was 39 percent smaller than that of the prior year’s fourth quarter, nor that the year’s total revenue, nearly $10 billion, about a tenth of IBM’s total revenue, was 23 percent less than hardware revenue in 2013. What is a bit puzzling, however, is the way investors and analysts tiptoe around the impact shrinking hardware revenue is likely to have on intake from software and services. Hardware remains a powerful engine for all of IBM’s business. The glass houses whose economic lives are measured in decades (even though individual items of apparatus are usually replaced every few years) have given IBM a foundation in big business and big government that few if any other companies have achieved.
Within the hardware segment, IBM is down to two server products, mainframes and Power boxes. (IBM also gets more than a third of its hardware revenue from storage subsystems and additionally sells a bunch of other products such as network communications devices.) During the fourth quarter mainframe sales were off by 26 percent compared to the prior year’s quarter, which IBM explains by pointing out that the product cycle of its flagship servers was ending and customers were very likely going to defer acquisitions until the next generation of big iron, subsequently announced as the z13, was available.
It is harder for IBM to explain the 13 percent drop in sales of Power boxes, which support the IBM i environment, the AIX Unix variant, and Linux. Sure there were some new products in the wings interfering with the sale of their predecessors, but when it comes to phasing in new generations of equipment, IBM is the best in the business. Basically, IBM is having a hard time selling Power-based systems. Customers may love the way Power-based computing centers get the job done, but they don’t love the high cost of the hardware and software to which they have become addicted. And with so many conversations about computing centered on the role of services from the cloud, it is increasingly difficult for IT executives to sell their managers on fresh hardware.
Ginny Rometty doesn’t have forever to show that she deserves the big pay, bigger bonus, and even more substantial stock entitlement. For now, investors seem to be patient, but the company’s future is not in their hands as much as it is determined by the faith and hope of IBM’s customers. If they lose their appetite for IBM’s goods and services, investors will be punished. And IBM would then let go of Ginny Rometty, not by accident, the way New York mayor Bill de Blasio dropped the fatally unlucky Charlotte, but rather with steely determination, a move that IBM calls an RA, for Resource Action. If that ever happens, disgruntled discharged former IBMers will start pronouncing RA “hooray.”