IBM's Biggest Write-off (July 1993)

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Gerstner's First Quarter Marked by Small Operating Loss, record Write-off - Yet IBM Stock Rallies

PHOENIX, July 27, 1993 - IBM announced today a record quarterly loss (about $8 billion) as a result of a record quarterly write-off (about $8.9 billion). Yet, the stockmarket greeted the news with a three-point surge in the value of the IBM stock. The reason? The news was not as bad as most people had thought. The stock markets don't deal in FACTS; they deal in PERCEPTIONS of facts.

That's why we pointed out in our last week's report that, "in anticipation of IBM's poor second quarter results, the (IBM) stock has already set several new 18-year lows in the last two days. Actually, we think that there is more potential for an upside surprise in IBM's second quarter report than the other way around. Brave tactical investors might even load up on the stock in anticipation of an upswing AFTER IBM reports its results on July 27" (see CMS BULLETIN 93-39, 7/20/93).

Those among you who took our advice, have reasons to smile. But, not for too long...

At the company's New York press conference today, IBM's new chairman, Lou Gerstner, did a lot of "tap-dancing" when answering the questions which dealt with his business strategy. "The last thing that IBM needs right now is a vision statement," he said. He argued that focusing on tough-minded execution of the marketing plans for the existing business units would do the trick.

We agree. But, with the emphasis on "right now" in the above Gerstner statement. After all, Gerstner has only been in the job for less than four months. Some of his new executive team members (e.g., York, Czarnecki) have been on board for an even shorter period. For a company as large and as complex as IBM, that's hardly enough time to even learn enough about the business, let alone devise some "grand plan" which would "save IBM." Meanwhile, Gerstner is telling his lieutenants not to wait for some great new plays to be called from the sidelines, but to keep their eyes on the ball, and grind it out on their own. As we noted in our CMS BULLETIN 93-37 (7/09/93) -- that's good; that's healthy. For the time being...

But, if Gerstner expects us to still buy his line about IBM not needing a "vision statement" by about the year end 1993, he'll be in for a rude surprise. Any enterprise needs a "vision statement" -- governments, big or small businesses, sports teams or even individual competitors. The statement must be SIMPLE and CLEAR -- one or two sentences at the most. That's so that even the lowest rung troops could understand it. At a minimum, it must address the questions such as, "what kind of business are we in?"; "what are our goals?"; "how are we planning to achieve them?" Without such clear statements of direction, the quarter of a million or so of the remaining IBM employees will be as rudderless as they were under the former IBM leadership. In other words, a true leader must hire the best people, outline for them his general game plan so as to ensure that they are pulling in the same direction -- and then get out of the way.

So far, Gerstner has displayed the latter skill -- getting out of the way. That's not a small feat considering the former IBM leaders heavy-handed style of sending edicts from the mountain top down into the valleys where the troops lived. But, getting out of the way won't be enough. The IBM employees, the IBM shareholders and the IBM customers have a right to expect the mountain to speak up once in a while. Until such time that we learn if the mountain's voice will be a thunder or a whimper, we reserve our judgment about whether or not the IBM stock is a long-term investment, or just a good trading opportunity.

Meanwhile, Gerstner and his new management team have displayed today at least one new positive characteristic -- the ability to read the financial markets' "tea leaves." The nearly $9 billion writeoff exceeded by at least 50% even the wildest guesses about IBM's second quarter charge. Yet, the IBM stock went up! What IBM did was "borrow" billions of dollars from its shareholders on account of future restructuring steps, without hurting the stock in the process. In effect, the $9 billion charge is a gigantic non-specific cash reserve.

That's artful tactical financial management. IBM saw an opening in the stockmarket's pessimistic short-term expectations and drove a Mack truck through it. In fact, it looks as if IBM could have probably driven a Boeing 747 through it and the stock would have still moved up. We don't know who at IBM deserves the credit for such a bold move. But, whoever it is, it certainly does not sound like the IBM of old.

The IBM stock soared today because IBM's operating results exceeded most analysts' gloomy predictions. As you can see from the tables and charts in this report, in our case, they actually were a little disappointing. We expected IBM to report operating profit, rather than at least a $100 million loss, as the Wall Street had been anticipating. The reason for our relative optimism was founded in the belief that IBM North America and the company's mainframe business showed some signs of recovery in the second period. IBM's release today of a basically break-even quarter underscored the depth of the overseas recession.

That's because we estimate that the North American profit increase since a year ago was well in the mid-double-digit range, on basically flat or slightly lower revenues. The main reason is that this part of IBM has been downsizing since 1985. Finally, the benefits are starting to accrue from all those tens of thousands of employees which the company has shed in this part of the world. IBM's international businesses, on the other hand, had been expanding their work forces through 1990 (see the charts). Which means that most of the additional employment reductions in 1993-1994 should come from IBM's major overseas subs, whose earnings have been dropping for at least the last three years (see the 1992 chart plus CMS BULLETINS 91-25, 4/30/91 and 92-18, 3/30/92).

The U.S. services business appears to be one of IBM North America's pillars of strength. We figure it has grown in the 50% range since the second quarter of 1992, even though IBM's worldwide service revenues were up "only" 27% (i.e., it was still the best business segment) during the same period. One of the key reasons is the IBM outsourcing and systems integration subsidiary -- ISSC. Asked in today's teleconference for consultants about how ISSC has done, Bob LaBant, the head of IBM North America, replied, "extremely well." He added that, "the kind of rates (of growth) we've talked about in the past are continuing (i.e., the 50%+ annual growth rates). We're still on that track."

LaBant also pointed out that IBM Canada, which has been reporting to him since mid-1992, was also doing well. "Canada has a very attractive SG&A" (ratio) relative to the rest of IBM, he said. As a result, "they've already done much of what they needed to do" in terms of cost and expense cutting. LaBant also said that most of the additional IBM employment cuts would take place "outside the U.S., " and "in the M&D world" (i.e., in the manufacturing and development parts of IBM).

If there were any "doubting Thomases" when we suggested last Fall that the PCs may be bad for IBM's business (see "Robbing Peter to Pay Paul" -- CMS BULLETIN 92-44, 8/28/92), there ought to be none left after today's financial release. The only hardware products that "did well" for IBM in terms of revenue growth were the PCs and workstations. As a result, IBM's overall worldwide gross margins promptly dropped 10 points since the second quarter 1992. But, more to the point, we figure that the company's hardware gross margins plummeted about 17 points!

So, there you have it -- that's what happens to IBM when the PCs and workstations "do well"! Any more "experts" suggesting that IBM should dump the mainframes and go with the PCs?