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IBM's attempt to write new chapter goes back for a rewrite

IBM's Watson
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IBM's Watson

We got an earnings report from IBM, and the picture they paint isn't pretty. The technology bellwether had a rough quarter and gave rough guidance.

It's no secret that IBM has been trying to transform itself from a hardware business to a services business for several years, but they are starting to hit a real wall in those efforts. Here are the revenues for various divisions for the fourth quarter (Q4), courtesy of Gartner:

  • Global Technology Services was down 4 percent;
  • Global Business Services rose 1 percent
  • Software was up 3 percent;
  • Hardware plummeted 26 percent

The problem is pretty obvious: hardware revenues are declining rapidly, while services and software are mostly flat.

And the guidance is tough. IBM's first quarter earnings per share (EPS) guidance of roughly $2.50 (14 percent of full year EPS) is well below the current consensus of $3.27. Given that they have said they want full year EPS of "at least" $18, that is putting a lot of pressure on the following three quarters.

Yikes. I counted at least 10 analyst lowering their full year guidance—most of them close to two percent lower. JPMorgan recommends that "investors take profits." But no one today has downgraded the stock yet. Most analysts have Hold ratings on IBM; only one (ISM) that I know of have an "Underweight" rating

The issue for the company is can they halt the slide in the hardware area--mainframes, servers and storage. Amazon and Google are building their own hardware, their own servers. Global Technology Services run data centers for companies, which is where the cloud services business is. It's like an annuity because the companies pay every year.

Global Business Services is largely a consulting business that is relatively flat, and analyzes a company's business processes and recommending new technologies. In Software, they are not in competition with business applications like Oracle providers—its really middleware like Lotus, software that helps the computers talk to each other. They are in a lot of competition with offshore providers Cognizant and Wipro.

The main issue for IBM is simple: their hardware business is declining, margins are lower mar, and they have had difficulties selling that hardware into other emerging market countries like China. In Services, customers want more low-cost, cloud-base services. The problem is that these are also low-margin businesses, where deals are much smaller than they have been in the past.

They need to move the business away from low-margin hardware (typically about 38 percent) and toward the higher margin software business, where gross margins are around 90 percent.

Elsewhere

1) Biotech goes parabolic, again. I've been asked repeatedly about the biotech rally (much of it around the JP Morgan Healthcare conference) and how much further it can go. It's been a long and uninterrupted rally:

IBB Nasdaq Biotech Index performance by year:

2014 up 11 percent;

2013 up 66 percent;

2012 up 32 percent;

Here's my take: the IBB is now about 25 percent above its 200 day moving average, and historically that is very stretched. Whenever that happens, like May and October of last year, it tends to pull back. Just an observation.

By CNBC's Bob Pisani

  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

Wall Street