Annex Bulletin 2013-06                            August 8, 2013

A partially OPEN edition



Apple Falls from Treetop (Analysis of latest market and business results of top 15 IT companies)



Updated 8/11/13, 8:00AM HST - adds Gerstner vs. Palmisano difference

Analysis of longer term outlook for IBM

In Troubled Waters Again

IBM Close Encounters of the Third Kind; Big Blue Feet of Clay - Redux; Break Up IBM? (again)


HAIKU, Maui, Aug 8, 2013 - Over 30 years ago, at a time when the world thought that Big Blue could walk on water (see TIME magazine cover, July 1983), we said IBM was sailing in troubled waters.  Nobody believed us, of course, least of all IBM executives.

We are in a similar situation now. When we said in Apr 2012 that IBM was stuck in its place with feet of clay while the marketplace around it was exploding, nobody believed us, either, least of all IBM executives.  Our media friends also remained largely mum about it. Witness the continued stock rise despite shrinking revenues (left chart).

Well, that illusion is now over.  Just like 30 years ago, the truth is slowly seeping out...


Back in April 1983, we had our and first "close encounter of the third kind" with IBM, to borrow the title of a famous Steven Spielberg movie. Except that instead of facing a UFO, Big Blue was sailing toward an iceberg, the PC iceberg.

The computer industry was changing rapidly from "big iron" to smaller systems.  A PC revolution was under way. But IBM did not see it coming.  It was still worrying about the Japanese PCMs (plug compatible manufacturers) and fighting yesterday's (1970s) battles.  And in doing so, IBM was converting its rental base to purchase.

Here's a recreation of a cartoon published in the April 1983 edition of the Annex Computer Report under the title "Is IBM Mortgaging Its Future?"

Later the same month (April 1983), this writer asked the then IBM chairman John Opel (the guy pictured on the TIME cover) at the company's annual meeting in Boston to explain why IBM was mortgaging its future.  I was referring to the company's first "financial engineering" effort  - the massive lease base.  IBM used the income from these asset sales to mask the weakness in its operating results. 

Not accustomed to being challenged, especially not in public, the IBM chairman was taken aback by the question. He stammered out his answer which failed to address the question. The following month, however, Allen Krowe, IBM CFO at the time, spent some time with this writer on the phone trying to put a coat of paint over his chairman's reply.

"Purchase is a natural order of things," Krowe crowed, trying to paper over the issue of weak operating results. 

Krowe asserted that the customers shift from rentals to purchase was not IBM-driven, but was rather market-driven (see ACR Jul/83). His explanation ignored the fact that IBM had raised the rental rates for a 3033 mainframe, for example, by about 42% between 1978 and 1982, while dropping the purchase prices about 40% in the same period.

That was the climate and the context in which our original IBM Iceberg encounter cartoon was created. And neither Wall Street nor the major media were none the wiser, as evidenced by the above TIME magazine cover.  Maybe they did not want to know. Or didn't care. (Sound familiar? See the 1985 cartoon - right - which did survive till today, which shows how little things have changed in three decades).

Fast-forwarding to 1985, the then new IBM CEO John Akers was forced to backpedal on the company's overly optimistic forecasts almost from the get-go. He spent the rest of his eight years at the helm backpedaling in vain.  The top-heavy "Battleship IBM" had a momentum of its own. And Akers was too much of an insider to be able to change its course. 

As a result, IBM was on a collision course with the PC iceberg, among others, that could have easily sent the Big Blue to the bottom of the ocean.  Only a last-minute change of command on the bridge averted the disaster.


Enter IBM's new captain, Lou Gerstner, April 1993. He was the penultimate "financial engineer." Right off the bat, Gerstner did what Wall Street loves to see. He cut costs and people. Mercilessly.  Within the first three months on the job, he wrote off $8.9 billion - by far the largest write-off the company has ever recorded.

Instead of breaking up Battleship IBM into a smaller and nimbler ships, a direction in which John Akers was already heading before being sacked, Gerstner opted for centralization and bigness. And for staying in the enterprise market, cozying up to his pals - the Fortune 500 CEOs.

Gerstner spent the next nine years perfecting his "financial engineering" skills, especially through a massive stock buyback program.  Insider trading also blossomed. Greed ruled supreme. But the company's growth suffered as did the profits. 

In the end, Gerstner and Akers distinguished themselves as Big Blue's worst CEOs (see the charts below). By July 2000, the time had come to dust off and refresh that 1983 cartoon:

Take a look at these charts which show IBM's 100-year revenue history...

You can see the five dips in the last 20+ years, each caused by different phenomena. Some were even good for IBM. The first two (Akers, Gerstner) were caused by executive incompetence.  Clearly, that's bad. The third and the fifth, however (PC, Pruning), were are result of deliberate management actions to taken to shed low or no profit businesses and improve profit margins. In other words, clean up the mess Gerstner had left behind. Which is good.  It's like surgery to remove unproductive or harmful tissues.


In the end, the best decision Gerstner made in his nine years at the IBM helm was naming Sam Palmisano as his successor. Because Palmisano accomplished what seemed impossible. He turned Big Blue around.  By focusing on quality rather than quantity, he made IBM a highly profitable company again. And he even managed to grow revenues despite sailing into head wind much of the time.

What was the basic difference between the two IBM CEOs? Gerstner was out to make himself LOOK good. Palmisano was out to DO good (for IBM shareholders).

Which did not go unnoticed. The stock went through the roof, set all-time highs. The shareholders were happy. The employees were happy. By the time Palmisano turned the reigns over to Ginni Rometty in Jan 2012, he was riding on the crest of the wave.  A perfect time to be an outgoing CEO. Not so hot to be an incoming one.


That was evident right off the bat.  Rometty stubbed her toe on her first at bat. IBM's first quarter 2012 were disappointing (see Big Blue Feet of Clay, Apr 2012). Our one line summary: "Three simple words: Lack of growth." Here's an excerpt:

What a difference a year makes. In the first quarter of 2011, Big Blue rode on the crest of the new mainframe wave.  Things were rosy.  The stock soared. IBM looked as solid as the Rock of Gibraltar, we noted in subsequent reports (see Wall Street's New "Rock of Gibraltar" and Big Blue "Rock of Gibraltar" Stands, Apr 2011).

IBM is still solid.  Like the Rock of Gibraltar.  Unfortunately, it is also stuck like the Rock of Gibraltar.  Stuck in the same place.  While the marketplace around the Big Blue is exploding, and the companies like Apple, Facebook  etc. are growing by leaps and bounds, IBM's first quarter revenues were flat.  Its hardware business was down 7% in the first quarter (right chart).

Since that time, the company has continued to struggle.  Here's our latest commentary:

August 6, 2013, 8:37 PM

IBM stock dropped nearly five points today. The market reacted to the news about the furlough in the IBM hardware division which was brought about by its declining business results (see MarketWatch story excerpt below).  

Some of the media asked for my reaction. This is what I said:

As usual, Wall Street are closing the barn door after the horse is gone. They cheered the disappointing second quarter results last month when this division (STG) led the declines and pushed the stock up. Now they are in a hurry to sell? 

So - Who is manipulating the IBM stock?  - I asked the day after. That's the question the SEC should still be asking if they are worth their salt.

I first said IBM was in decline in April of last year (Big Blue Feet of Clay - Analysis of IBM 1Q12 business results and 5-year forecast). I even created this image to go with the story in order to emphasize it:

But "where ignorance is bliss, 'tis folly to be wise" (Thomas Gray).

I have nothing new to add now.  The only thing left to do is to republish that Apr 2012 piece. Because everything I said back then is still relevant today. It's just that 16 months have been wasted since I first warned about the IBM decline and an urgent need to change - create or get into new markets. 

That has clearly not happened. So here it is again...
Big Blue Feet of Clay- Redux 



Clearly, IBM is in troubled waters again and has been for some time, Wall Street's ignorance or gullibility notwithstanding. For the fourth time in three decades, IBM seems sailing into a head wind enroute to an iceberg,  Will it hit it this time?

Well, news from the bridge is not encouraging. Ginni Rometty, the current CEO, usually provides employees with a brief video commentary after each quarterly earnings. They are typically self-congratulatory remarks. But in her April 2013, address, Rometty's usual pep talk included comments that employees need to work harder, according to a story in the Apr 24, 2013 Wall Street Journal edition (subscription needed).

The story, which described Rometty's comments as "unusually blunt," said the IBM CEO told employees they need to speed up the company's shift to new computing models to get back on track.

"Where we haven't transformed rapidly enough, we struggled," she said. "We have to step up with that and deal with that, and that is on all levels."

Good message. Late, though. We said as much the year before.

At the same time (Apr 2013), veteran IBM hardware leader Rod Adkins was pushed aside and replaced by Tom Rosamilia, who used to work for Adkins before taking on a corporate strategy job (click here for a CRN story).  And it was Rosamilia who carried out the latest cuts - the one-week furlough of most of the STG employees later this month (see the story below).

So what do these latest IBM moves tell us?  First, they tell us that the IBM CEO is feeling under the gun. Justifiably so, given continued lack of growth.  IBM is still stuck in the same old markets as it was a year and a half ago when she took over.  The company has not moved beyond the enterprise market. And yet that's a shrinking pond which is getting more stagnant every year. That was the point of that Big Blue whale image we published in Apr 2012.  And of this dinosaur one published in 1996 (left).

If IBM is to grow again, it needs to CHANGE. Radically. It needs to find or create new markets. Cloud, "smarter planet"/business analytics, emerging markets - the moves IBM has made in that direction - just aren't enough. And Big Blue is still playing in the same old enterprise pond populated by the same old shrinking giants.

If IBM is to survive and grow again, the company needs to shed the self-image of a big corporate vendor. That ship sailed long ago. The Fortune 500 companies have been shrinking for the last 30+ years, and are collectively on their way to extinction, like the "white dwarfs" of the universe.


But unlike the doomed "white dwarfs," such as Sirius B, for example, a shrinking binary star that's about the size of the Earth but is about a million times more dense than the Sun, the corporate dinosaurs have a choice. They can mutate. They can split up like the amoebas so as to continue to grow in the aggregate. Alas, few of their leaders have the vision to see that and the courage to execute such a bold move. 

That seems to include IBM.

For the IBM CEO to blame the crew for the ship's slow speed, and exhort them to "work harder," is an indication of both her frustration and a lack of vision.  Whatever happened to the "buck stops here"-leadership?

Working hard has never been a problem at IBM. IBM's problem is and always has been a lack of creativity and courage to break out of the corporate shackles and rulebooks the 112-year old company has generated.  If Rometty expects the IBM employees to follow her, she must first take responsibility for the lack of progress herself. And then she must lead them by demonstrating clear vision and boldness to change. For, that's the missing ingredient here - willingness to carry out real change, implement a radical transformation of the business.

When IBM's Gerstner faced a similar situation in 1996, we suggested he break up IBM (see "Break Up IBM!", Mar 1996).  No go.  That IBM CEO was more interested in empire-building than giving up central control to let individual parts grow faster (see Louis XIX of Armonk).

Ten years later, when Palmisano struggled with the stock slump in 2006, we suggested IBM create a new Baby Blue company to deal with small and mediums size companies (see "From Little Acorns Might Oaks Grow?", Nov 2006). Again, no go. The idea was "too radical," we were told.

Well, that's how Big Blue Feet of Clay are created - out of missed opportunities to mold the clay before it hardens.

Would we recommend now to Rometty to break up IBM?  Why not? What does she have to lose? Her ideas aren't producing desirable results anyway. She said as much herself. If the transformation is anything short of "radical," and IBM stays the current course, it may head straight for that iceberg again.  You don't want to be standing on the bridge when that happens.

Back in the 1980s, it was the PC. Now it is the Internet and a whole slew of under- and above-water icebergs a large company has to navigate around if it is to survive.  Smaller boats are more nimble, easer to maneuver.

Perhaps this morning's stock chart can serve as encouragement.  They say, a "picture is worth a thousand words." And that displaying a flag or a symbol upside down is a sign of distress.  Maybe it's time IBM realized that. It is a company in troubled waters again, a ship in distress.


Happy bargain hunting

Bob Djurdjevic


IBM employees in systems business to take week furlough

August 6, 2013, 9:59 PM (MarketWatch excerpt)

International Business Machines Corp.  is asking the majority of employees in its lackluster systems business to take a mandatory extra week of vacation this month, instead of taking more extreme measures such as job cuts. Last month, the company reported disappointing second quarter results, including a 12% drop in revenue for the systems and technology business. It was the seventh straight quarter of year-over-year revenue decline for the business, which includes hardware.

On Monday, the tech giant told employees in systems and technology, and employees in its integrated supply chain who support them, that a majority of them in the U.S. will take a mandatory week furlough, beginning either August 24 or August 31. They will receive the equivalent of one-third of their pay for the week. Executives will not be paid for the week.


Volume XXIX, Annex Bulletin 2013-06
Aug 8, 2013

Bob Djurdjevic, Editor

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