Big Blue’s Reckoning: What IBM’s Worst Day in 115 Years Actually Means

In this episode, we analyze IBM's historic stock drop and explore what it reveals about market reactions, customer priorities, and the importance of execution in business strategy. Join us for insights on managing risk, recognizing trends, and staying agile in the fast-changing tech landscape.

Transcript

SPEAKER_01 0:00

Views expressed are solely those of the speakers and do not represent this show or its team. Anytime we get news or price action that uh that comes in, whether it's positive or negative, right? Yes. We we want to we want to take a look at what that means for our thesis and and uh and whether or not you know there's a crucial leg of that thesis uh that that uh doesn't support owning it uh or supports maybe buying more on weakness. And so that's what we're doing right now.

SPEAKER_02 0:34

Welcome to Built to Last, conversations about wealth, work and life. I'm Wade Locos, and I'm joined by our Chief Investment Officer, Gary Aiken. Gary, welcome back to the show. Great to be here, Wade. Yeah, Gary, I want to open with one number. 25%. On July 14th, IBM had the worst single day in its 115-year history, wiping out nearly $67 billion in market value. But the headline miss was relatively modest. Revenue fell short by less than 4%, and earnings missed by eight cents. When the market reaction is that much larger than the miss, investors are pricing in something bigger than one bad quarter, right? So, Gary, let's start with the question our listeners are asking. When a 150-year-old company built on stability has its worst day ever, is that a real crisis or is that a market that got ahead of itself?

SPEAKER_01 1:28

You know, I think in IBM's case, it is kind of a real crisis. Um, you know, uh, this 25% drop came because, as you said, they had to pre-announce earnings when a number of large contracts uh for uh software sales did not materialize at the end of the second quarter and um and really sort of towards the waning days of June and caught the company off guard. And um, and I think it, you know, it's a real crisis in that um, you know, IBM has been a company that has been able to forecast pretty well what its contracts and sales are going to be, you know, and for for material items like that to occur and then be blindsided by it, uh, it is a pretty big crisis.

SPEAKER_02 2:27

Well, let's walk through what actually happened, okay? Because most people saw IBM crashes and stop there, right? But IBM released preliminary results eight days early, which immediately told the market this was going to be more than a routine of earning this, right? So CEO Arvin Christina then admitted that the company saw customer spending shift, but failed to adapt quickly enough. To me, that matters more than the numbers themselves. Customers didn't stop spending, they redirected the money from the software and consulting toward the servers, storage, networking, and chips needed to build AI infrastructure. The priority became securing the hardware first and buying the software later. That is why Microsoft ServiceNow and Salesforce also failed the same day. Investors saw IBM as a warning that spending priorities may be shifting across the entire technology sector. Gary, how unusual is it to see an enterprise cap spending reprioritize that quickly? And what does it tell you about where we actually are in the AI investment cycle right now?

SPEAKER_01 3:32

Well, in the AI investment cycle right now, there has been story after story about two things, bottlenecks and shortages. And and uh the bottlenecks are in all kinds of different uh products and um uh from you know from analog uh chips uh to uh to just finding electricians to to build things in data centers to memory. And then this is where we get to shortages. And so there have been reported shortages of memory and uh and CPUs and GPUs, and people going out of their way to pre-fund contracts to buy uh buy semiconductors and memory chips in the forward market. And so they're taking, you know, what what we assume is what happened is that a lot of these companies who were going to be buying you know software and other services uh from IBM just needed to divert to buying GPUs and buying um memory, uh and which is in which is in a shortage condition. Um and uh and and we think that that is what happened.

SPEAKER_02 4:51

Well, IBM was also betting in his new Z17 mainframe, it would be the strongest infrastructure loss in the company's history. Instead, infrastructure revenue drops 7% for the quarter. What does it tell you when a company's own bet on the AI trend gets run over by the AI trend itself?

SPEAKER_01 5:12

So I think that we have to separate for our audience who may not be sort of familiar with you know what what's really what we're talking about, we say Z17 mainframe, right? A mainframe is the kind of stable operating environment that you need when you are a bank, a large financial institution, and uh or something like that. Those are the main buyers of mainframe solutions. The other place, if you don't want to have a mainframe that you can store all of your data and comp and do all of your compute is in the cloud. And one of the things that IBM does is uh security around cloud solutions and security around the mainframe. And uh, and so this Z17 mainframe infrastructure uh that is an upgrade from the the latest, the Z16, uh, is is sort of the next generation of that mainframe. And the buyers of that for their banking customers potentially could be the Amazons, the Microsoft's who manage other cloud applications in Azure and and and uh uh Amazon Web Services. And so we get back to this idea that um, you know, uh I don't I don't think that you know what will happen ultimately is that uh the Z17 will be unsuccessful. It's just that, you know, I'm speculating here. If the main contracts were between the Microsoft's and the Amazon Web Services who would be normally buying from Amazon and they need to divert those to NVIDIA and Micron uh to secure chips uh for GPUs and memory, then that would explain the big drop. And uh and like we said, there's so much of a fluid situation going on right now uh that uh it's possible that those companies too got it wrong and had to scramble at the end of June.

SPEAKER_02 7:21

Well, let's talk about what has happened, though, because HBC HSBC's already downgraded IBM to reduce from whole. They cut their price target from 231 to 190ish. Other analyst targets on this, you know, on this IBM range is from anywhere as high as 375. That's a 96% spread between the most bearish and the most bullish reads on the same company. What does that spread tell you about how unsettled this picture is currently?

SPEAKER_01 7:54

Yeah, I think you know, analysts uh on the street tend to have different time frames for their forecasts. Um the most typical one is a 12-month forecast. But I think when something like this happens, you know, some analysts uh are are scrambling to update their models very quickly, and others take a longer approach. And so the difference between the highest and the lowest on the street could be a matter of, you know, uh some analysts moving quickly and some analysts taking a little bit more time to digest the situation before moving their price targets around.

SPEAKER_02 8:30

Yeah, and you know, the full result, what lands on the 22nd of this month. What what what are you watching for specifically on that call to know whether this was a timing problem or an actual real demand problem?

SPEAKER_01 8:45

Yeah, I think uh I'll be I'll be looking for the questions that are going to be along those lines from analysts who are on the on the conference call. Um, and also to get a sense from IBM, um, you know, whether or not they are seeing serious issues with respect to software and consulting. Yeah. Um I agree. You know, we've seen we've seen infrastructure, you know, IBM has four main business lines. Software and consulting sales is one, uh, infrastructure mainframes is another. Um uh and uh and and then compute is a third, and then the final is sort of financing. Right. And and the two middle ones that I mentioned are both growing sort of mid-single digits uh to high single digits in terms of revenue, and you know, you know, low, low or uh, you know, high single digits to mid-teens in terms of profitability. Uh software sales has been the one, software sales and consulting has been the one that's been trailing off significantly. And uh and it's something that that that that I think will be a focus for whether what we what we what management really expects from that going forward, given that that is that's what's being really disrupted by AI.

SPEAKER_02 10:07

Yeah, let's let's let's touch on that a little more. You know, it's it's IBM's you know is primarily hardware company. Hardware is not where it makes most of its money, right? I mean, it's just software represents, like you were talking about, about 45% of revenue, but nearly two-thirds of the profit. So when you look at gross margins above, you know, approximately 80%, the hardware is really just the doorway, right? It just it gets you in. It's it gets IBM inside some of the world's largest companies where it can build decades-long software and service relationships. Now think about that, because this is why the full picture matters. Margins improved. Red Hat grew 11%, and IBM is generative AI business surpassed almost $13 billion, 12.5, I think. Market focused on one disappointing quarter. It paid far less attention to what IBM is building for the next decade. So I think when you look at those, Gary, what is the profitable part of this business that, you know, that is still growing and operating margin is exp why why did if if if that's happening, right, if if we're getting those things, why did the stock get a cut by a quarter in a single session?

SPEAKER_01 11:21

I mean, it doesn't make sense. No, it it and it doesn't have to make sense. Um uh, you know, we we know that one that in recent weeks the single stock volatility, and I think we we maybe talked about this on on a previous podcast, but single stock volatility has gone up dramatically. Um and and so any move that's that's unanticipated, any move that that is happening with individual stocks, especially in the tech sector, are gonna be more dramatic than than they otherwise would be. Um secondly, anytime you pre-announce and you pre-announce bad bad things, the first move by by traders is to sell. And when there's no when there are no you know buyers on bad news, uh, you know, the price can go as low as it needs to go to clear the market. I've never thought about that. When the dust settles, we'll we'll we'll have more information and we'll figure figure out what's going on. But for the for the you know, as we're looking at the stock now, we bought it for our clients uh at basically this price two years ago. And so it hasn't really it hasn't really moved moved very much. Uh there's been, you know, it it moved up a lot, and then it's it's uh with this move, it's come right back down. A 25% drop in a single day is is uh definitely out of the ordinary. Um and it's it's why you need to have a diversified portfolio um so that it so that one single stock doesn't uh take down your entire net worth.

SPEAKER_02 13:03

Let's walk the listeners through why a hardware slowdown threatens a software company. Does a pullback in infrastructure spending actually put the high marginal software engine at risk, or does that kind of get overstated by a market reacting to headline forecast that reads the segment data?

SPEAKER_01 13:21

My thinking on this is that the software and sales business is being separated. That the old model, like you said, was you buy the hardware, you buy the consulting services around the hardware, and it's a long-term project. And uh, and of course, there's that old saying, uh, nobody ever got fired by going with IBM. Um, I I'm not sure, I'm not sure that anybody who's you know uh you know five or six years younger than us has ever even heard that phrase. Yeah. Um first time I've heard in a long time. Yeah. For a long time, that's what IBM was. And I think it's a different, it's it's the reason we've got a, you know, another reason for this 25% drop is a market realization that uh maybe there's something fundamentally different about this IBM that is not necessarily solvable um uh in the ways that that uh that we had thought about thought about it. And we really need to think about uh not thinking about this business as a conglomerate of these different parts of the business that all sort of harmoniously work together, but as separate and distinct businesses that maybe have less to do with each other than we thought.

SPEAKER_02 14:42

Let's draw a line between a timing problem and a demand problem. If the delay deal that CEO mentioned showed up close next quarter, this this was a timing thing, right? If they never show up, this is a demand. How do you tell the difference before you you know before the company tells you?

SPEAKER_01 15:01

You can't. Yeah. You can't. I mean, that's the that's the that's the tough part about this and why I think there was a lot more selling. Is that hey, uh that sounds a lot of why we buy a stock, right, is confidence in management and management's ability to make good decisions and to forecast their own business. This was a this was a shock not just in losing a contract and and not having not having revenue be exactly where we thought it was going to be, but also an indictment of current management's ability to to uh to really understand their business and their customers.

SPEAKER_02 15:42

Well, do me a favor, and just just quickly rate his message, in your opinion. What did you think?

SPEAKER_01 15:49

I would rate it pretty poorly. I think you and I still have a lot of questions that we can't answer on this podcast, and I don't think anybody can really answer them. Uh and and we're all waiting until the till a conference call on uh April 22nd to ask more questions. And um and so, you know, with with that regard, I mean, they they they really didn't tell us a whole lot of information that made a whole lot of sense. And from analyst reports that I've been reading uh you know in the days since, there still isn't a whole lot of uh you know clarity on what that statement really meant.

SPEAKER_02 16:29

Yeah, there's two groups listening right now, right? You got the investors who own IBM and wondering what to do, and you have business owners watching this from the sideline. But both should pay attention because this is bigger than IBM, right? It's a lesson in what happens when customer priorities change faster than a company can respond. I think that's it's a little bit of a CEO problem, in my opinion. So whether you're managing a portfolio or running a business on Main Street, I think that's something we have to address when we're looking in the future. So, Gary, for a client holding IBM right now, what's the responsible way to think about a 25% single-day drop? Reassess the thesis or recognize the market may have re overreacted and just wait for July 22nd. What do you do?

SPEAKER_01 17:11

We're reassessing our thesis. Um, you know, anytime we get news or price action that uh that comes in, whether it's positive or negative, right? Yes. We we want to we want to take a look at what that means for our thesis and and uh and whether or not you know there's a and a crucial leg of that thesis uh that that uh doesn't support owning it uh or supports maybe buying more on weakness. And so that's what we're doing right now.

SPEAKER_02 17:42

So is there a broader read here for anyone running a service subscription-based business? I mean, if you think about it, if large enterprise clients will delay a software in order to chase scarce hardware, what does that say about how fragile or even sticky high margin recurring revenue can be when capital priorities just shift?

SPEAKER_01 18:02

I think there's a a couple of lessons to learn here. Uh one one lesson is that as this AI revolution progresses, there's going to be more fluctuation, not less, around around what what it is, what it means. And that means that there's gonna be a lot more nimbleness and a need for more nimbleness around management. Um we're gonna have to take or managers of businesses are going to have to take risks. They're going to have to realize that there may be some things out of their control that they that they that they're gonna just have to deal with. And uh, and so risk management from that perspective, both positive risk and negative risk are are gonna be things to think about from a management perspective.

SPEAKER_02 18:55

Aaron Powell Well, let's expand on that. What does the broad software sector sell-off on the same day tell you about how interconnected the market considers enterprise tech right now, even when the individual companies have not reported anything?

SPEAKER_01 19:10

I think it means, and what we expect it it means, uh given that you know we reduced our software exposures across the board uh earlier, uh, was that um you know the the demand for AI hardware or demand for uh hardware to support additional AI capabilities means that those AI capabilities are providing huge in-house or or compute solutions to software problems that were previously addressed somewhere else in the software ecosystem. And and if people are rushing to divert resources to additional compute for AI solutions, it means that they are probably thinking about or actively reducing their uh their dollars that that they're committed to spend for legacy software.

SPEAKER_02 20:11

Yeah, but here's a part of the story I just have keep it just I keep keep coming back to it because I think it applies to every business I own and every business owner listening today. IBM was not blindsided, right? Krishna said that he he basically he made a mistake, right? They saw the shift in customer spending. The problem was not the way they missed it, the problem was that they didn't respond fast enough. And to me, that's an important distinction, right? Missing a trend is a strategy problem. Seeing the trend but moving too slowly is an execution problem. Those are two very different things. In many ways, execution is the harder problem to solve, right? Strategy can change in a boardroom over the course of an afternoon. Execution requires changing how an organization makes decisions, reallocates capital, reprioritizes projects, and gets thousands of people moving in the same direction. That's a much harder thesis, especially in a company, the kind of history that IBM has, right? And I think there's a lesson in that for every business owner. The market usually gives you signals before it gives you consequences. The real question is not whether you see the change coming, it's whether you can act on it before your customer forces you to act on it yourself, or they throw a decision down your throat, right? So, Gary, from an investment standpoint, how much of a company's long-term value comes down to exactly that, right? The distance between recognizing a shift and actually moving on it, in your opinion.

SPEAKER_01 21:48

Yeah, the the knock on IBM in the past was that it was an extremely stayed, old line, bureaucratic organization. um you know had not uh recognized shifts in the technology business and was and was not really executing on its ability to do that and I think what uh one of our one of our you know assumptions in our thesis was that uh this was a company that had figured out that that was wrong it had made some excellent acquisitions uh you know to to move to move IBM towards the present in order to move towards the future uh and uh and so this you know this was a real shock because uh because it seems like that institutional inertia is still lingering there in the background of IBM absolutely it's it almost feels like history repeated itself you know um but if you had to name one thing every business owner should take away from this you know this is a hundred and fifteen year old company getting caught flat footed by a trend it saw coming, what would it be? Yeah I I would say spend more time with your customers. Excellent excellent answer. Yeah we all sit behind our computers and all that kind of stuff. I think getting getting out having having a meal with your customers picking up the phone and talking to them on a on a Saturday or a Sunday afternoon uh you know when when there's nothing else in front of them uh you know that maintaining those relationships are really important um and uh and I don't know that that's what happened here that that IBM was speculation it's all speculation but I think for business owners and for for anybody in a you know if you have a sales problem you need to go back to sales 101 and it's a people business it's relationship management and staying in front of your customer you know they're they're more likely to tell you what's what's really going on um and and that that can help you either solve a problem that they you know that they didn't know they had you can be solutions oriented or or at least have a heads up that that something is coming that is out of their control.

SPEAKER_02 24:12

Yeah it's like like any sporting event sometimes you can just feel the momentum shifting if you pay attention to it right so okay let's bring it home you know what we know we're getting ready to do I'm gonna ask you three really tough questions and I guess the big thing we want to try to keep you know Jen you know if let's talk about companies we talked about profitability growing core business that you know that one of the that's been around forever that just had the worst day in its history right so the first question is what is the single most important thing that matters right now when it comes to how investors should think about IBM specifically and I would say more about enterprise tech more broadly I think the one thing that investors should think about and the one thing that we're gonna be thinking about is is the sum of the parts greater in valuation than uh than the uh the the value of the business is an ongoing concern.

SPEAKER_01 25:15

I think uh that sum of the parts valuation is going to be really important.

SPEAKER_02 25:19

What are you watching for you know I talk about next six next six months but really we're talking about in a few days so what are you watching for on July 22nd when the earnings comes out just to remind everybody and over the next six twelve months that every person should be thinking about or have on their radar let's talk about after that report comes out.

SPEAKER_01 25:41

Yeah after something like this I want clarity and visibility. Yep. And I don't care if it's negative give me the bad news but I want clarity and visibility.

SPEAKER_02 25:53

Yeah. And finally what's the one thing investors need to avoid right now when it comes to reacting to a headline like this one.

SPEAKER_01 26:00

I think this is uh a crucial example of why you don't put all your eggs in one basket you know even if you're diversified amongst tech that's still diversification. Um diversification is crucial. Yep.

SPEAKER_02 26:16

Agree. You know the noise around a drop like this is loud most of it you know treats a 25% move as proof of a story rather than the start of a question. What actually matters is whether the deal IBM says got delayed shows up next quarter or never shows up at all. We we will know more after the 22nd. What does not change regardless of what that call says is the lesson underneath it. Seeing a shift coming is not the hard part, right? Moving on it fast enough. That is true for a 115 year old technology company and it's true for every business represented in this audience. Today's conversation raised the question about how a move like this affects your own portfolio or how it connects to decisions you're about to make inside your company that's exactly what our team of Concord Wealth Partners here to help you with. Gary, great conversation as always thanks Wade. And that's exactly why we call this Built to last.

Announcer 27:19

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