Your pal Deep Throat here.
I have waited until MSFT (Azure), AMZN (AWS) and GOOG (Google Cloud) reported their Q4 2020 and full year 2020 results to add my commentary. Before I do so, a quick recap on what I have said in other letters/memos:
1) Q4 in EU looked awful, but I wasn’t certain about NA
2) I have maintained that the company is intent on moving to ~200k employees after SpinCo
3) The company will move to limit direct sales, and screw the rest
4) Will NOT become a mainframe only company
5) All of the action is financial gaming (my LONG held belief), until we bite the bullet on #6
6) IBM is spending 6b a year on debt repayment which is the same as RD&E and the Dividend. All this is untenable.
Unfortunately, (to use the phrase from last time), as you can see I am correct. So lets dig in to the disaster that was Q4 2020 and really all of 2020, as well as look in the 2021 crystal ball.
Krishna and Kavanaugh (surely the worst CFO in recent memory), sounded, well I really don’t know how to describe how they sounded on the call. Embarrassed? Chastened? Contrite? Full of sh–? Probably all four. To start with, the appalling top line numbers contained something really telling. While pre-announcement I knew EU was bad, but I wasn’t clear how NA did. It was worse than I imagined.
EU had a drop of 8% YTY, while NA had a drop of 10% YTY. I want to put that in perspective for you. You have probably heard of “recurring” and “transactional” revenue. IBM receives much of its revenue in recurring. Every company on the planet loves this type of revenue. Its like GE selling aircraft engines at cost (a transaction) so they can make money over the twenty year life of the engine on maintenance (recurring). AWS loves this too. Low balling the price of entry to get customers for years to come. (One reason they’re k–ling it right now).
So, for IBM to have lower Q4 numbers 2020 than 2019 by 8% for EU or 10% NA, then something massive happened to transactional revenue (assuming flat revenue in recurring). In other words, customers were not buying. It’s not just the old “well mainframe had a great Q4 2019” story. A miss of at least 25% in transactional revenue per EU and NA. Now to be fair, K&K both said that the COVID-19 issue affected customers willing to buy. Which on the surface seems reasonable. Except that is for Azure, GC, and AWS, who saw massive increases in revenue. Although GC LOST money which simply illustrates the price of entry. And they shouted how they’re investing in GTM. What a novel concept.
K&K’s response to the miss was, well amazing. Kavanaugh essentially said, (not a quote, but the meaning), “Well, sure we missed our targets in ELA’s, but that just means we will close more ELA’s going forward.” Can you imagine a sales leader or GM standing in front of the CFO with that story. “Well sure Jim, I missed for the quarter, but look how much is now set for the next quarter. You should be thanking me.” Kavanaugh’s head would explode all over his shiny conference table.
Secondly, they really didn’t want to talk too much about 2021, instead right out of the gate, using the overused word “transparency” to justify talking about 2022. As in, “In the interest of transparency, we want to look at 2022 as much as 2021.” (again not an exact quote). They also repeated the story that from the past few calls that IBM will grow at mid-single digits. Which I take to mean 5%. But even that could be lost if currency hedging goes sideways. So, all in all, this wasn’t just bad, it was catastrophic. And given the growth in AWS, GC, and AZURE, IBM AA’s and A’s have no excuse, and we continue to lose share.
It turns out my estimate of spending 6b a year to pay back debt wasn't far off. The number was 7b in 2020. Therefore IBM is creeping up on 20b a year just in RD&E, Dividend, and Debt payments. This is simply impossible to maintain. Krishna said that he wants the company to be more entrepreneurial and Kavanaugh said they will spend more on RD&E. To both of these statements, I simply ask, “how?”
Go back and read my earlier “Letters” or “Memos” if you want to see where I believe all this is heading. But to simplify. SpinCo removes 90k HC. And remove 20% of the rest for a total of about 200k-220k. However, and I hate to say this, but Q4 was such a sh– show, that everything has to be accelerated if IBM wants to increase RD&E and maintain the dividend. (Hint, we cannot).
To reiterate; normally layoffs are planned many months in advance, often the year prior. IBM is not fast at anything, even this, usually. However, Q4 was a wake up call for two main reasons. Firstly it showed that whatever changes K&K had thought they could spread out over the next eighteen months needed to be sped up. (This was my estimated time line too). Secondly, given the success of the competition, right now AWS and Azure (it will be interesting to see how ORCL does), while IBM declined, shows to everyone, including Wall St, that IBM doesn’t have products that are fit for purpose. In other words, there is nowhere to hide. It can’t ALL be COVID ALL the time if the competition is executing in the same environment. And as for our (newish) Brit cloud chief Howard Boville having a go at Gartner “’Cus they just don’t get hybrid cloud.” What would Trump say? Oh yeah… “Sad.”
Which leads us to the 4b in restructuring charges for 2021 and 2022. IBM has a massive issue getting SpinCo out the door (as I have detailed), profit per employee that is now 25k Vs 11X that at MSFT, and even 3X at ORCL. Think about that. Even Oracle, is 3X more profitable per employee than IBM (well per their last qtr). My biggest complaint has been the inundation of BCG/Bain thinking at IBM. As I have explained, look what they did to shareholder value at HP. Given the entrenched group-think at SVP level, the fixation on BCG/Bain, the AA holdovers, I don’t see this changing. And a new leader in Strategy (from Bain!).
Krishna absolutely has to get his arms around the situation. As I explained the BoD are useless. How else to explain their failures with Rometty. This is now all on Krishna. The new co-Chair Gary Cohn will be digging deep (a safe bet), but he’s a finance wonk, not a techie, so I expect him to be clear eyed on IBM spending/direction/etc.
Will he be a York though? Remember Jerome York? I do. During a blizzard he stuck a snowplow to the front of his pickup and made his own path to Armonk. He wasn’t f—ing around. I remember Gerstner (who had a good theatrical flair, would take off his jacket, roll up his sleeves and stand behind his chair. It’s a way to show, “I’m in charge, AND I am ready to work. And so should you”. He knew a great deal about body language). Regardless if you loved or loathed these guys, you knew who was boss. I just don’t get that sense from Krishna. Could you imagine Krishna saying, as Gerstner did, “I’m the one with my hands around the throats of my senior executives.”
Where is this all going? Think GE a few years ago. The once sacrosanct dividend was cut from 24c to 1c! They fired their CEO AND their CFO. They sold private jets (unlike IBM who buy them). Secondly, the Q1 will not be any better. How can it? We still have COVID. Customers are still nervous, according to IBM. And according to reality (always a good choice), they prefer to buy from someone else. Oh, and here’s a snippet. Many sales reps (who have the “500”), don’t even know what accounts they’re covering yet. Third of the way through Q1 and many sellers have no idea who their customers are.
I still believe IBM will move to 200k faster than they anticipated even ninety days ago. I don’t see higher numbers than I have anticipated being laid off, but I do see an acceleration on getting there. Unless, they throw profit and dividends out the window to afford investments in the company. I live in hope.
Until next time.
DT