IBM has outperformed the enterprise competition in the software solutions space, implying that the Big Blue is more thoughtful about identifying and capitalizing on industry trends. The company is expected to generate much of its incremental $16 billion in revenue by 2015 via the solutions offered by Smarter Planet, Business Analytics, and Cloud Computing.
IBM is generating stable revenues from Business Analytics and Smarter Planet, where data is gathered in both the physical, and virtual worlds then analyzed and can be used to take action. In fact, these two areas provided some cushion when software and services revenue were hit due to a drop in enterprise spending.
Revenue from Business Analytics grew 28 percent and Smarter Planet advanced 15 percent in the second quarter when quarterly software revenue of $6.2 billion was flat as reported, and up 4 percent at constant currency. Key Branded Middleware, which accounted for 64 percent of total software revenue in the second quarter, increased 4 percent at constant currency, in line with the market.
Global Business Services segment revenues were down 4 percent (down 1 percent, adjusting for currency) to $4.7 billion.
In the first half, the company's Business Analytics portfolio of services and offerings were up 13 percent and had revenue growth of more than 20 percent in the Smarter Planet portfolio, driven by industry specific solutions and Smarter Commerce and Smarter Cities offerings.
It all started in 2010, when IBM split software solutions organizationally as it recognized increasing digitalization and the resulting opportunities. In January 2010, IBM revamped its software organization into two groups: Software Solutions and Software Middleware. The company had observed profound changes in customer needs and application demands.
"Although Smarter Planet is a marketing monitor, underneath is a real trend in the digitalization of the physical world. Just as back offices have been increasingly automated, IBM is working to digitize front offices in its Software Solutions effort," UBS analyst Steven Milunovich wrote in a note to clients.
Filling in these solutions has caused IBM to make a number of acquisitions, some under the radar. Software Solutions has bought 14 companies. IBM realized that analytics would be the foundation for next-generation solutions and had moved to fill in holes with Cognos and SPSS. During the first half, it spent almost $2 billion to acquire 8 companies, including Vivisimo, Varicent and Tealeaf which closed in the second quarter.
IBM bought Varicent in corporate performance management; Clarity in financial governance space; Algorithmics in financial risk analysis; and Tealeaf in customer experience analytics.
In e-commerce, IBM covered the backend with Sterling Software then added Coremetrics to track consumer interactions in the Web and Unica for marketing campaign software.
"IBM has "business blueprints" by industry that map out its plan of attack and where acquisitions are required. Ideally, the company is looking for large building blocks that can apply to multiple industries," Milunovich said.
IBM can verticalize the solution using its industry consultants but wants the code to be about 80 percent common and 20 percent customized for the industry.
Among the rivals, Oracle Corp. (NASDAQ:ORCL) is probably the closest and has responded with acquisitions of ATG and Endeca. SAP AG (NYSE:SAP) is in the ballgame. Hewlett-Packard Co. (NYSE:HPQ) is trying to catch up with Vertica and Autonomy.
"It appears to us that IBM has been more thoughtful than most vendors in thinking through industry changes and creating end-to-end solutions by daisy-chaining acquisitions while integrating the code. This is the "how" behind IBM's Smarter Planet success and part of the "why" behind IBM's selling success," the analyst said.
IBM has indicated incremental revenue goals in 2015 of $7 billion from Smarter Planet, $6 billion from Analytics, and $3 billion from Cloud. That totals $16 billion though it is offset by declines in mainframes and microelectronics, etc. to result in 3-4 percent growth for the entire company. Still, over half the revenue from the three growth initiatives is software, which will aid IBM's gross margin.
"If IBM is to succeed is accelerating revenue gains, which we view as the key to a higher EV/FCF multiple, it is likely to come from these three areas," Milunovich noted.
About half of the Smarter Planet solutions depend on cloud capabilities, defined as data living outside the data center based on automation, virtualization, and provisioning. The question in the shift to cloud computing is whether the increased efficiency of the cloud in utilizing computing resources and the resulting pressure on spending will be offset by new workloads, such as Watson being used in human-intensive applications like health care.
"We don't know the answer, but we do think IBM is better positioned than most to succeed," Milunovich added.
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