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Ahead of Q2 Report, IBM Reflects on Ginni Rometty's Busy Year So Far

After lots of divesting, lots of investing, growth remains elusive.

Shareholders of the computing services giant IBM got a nice surprise earlier this week in the form of a major partnership with Apple to resell iPhones and iPads. Indeed, IBM shares rose two percent Wednesday after the deal was announced.

But today it’s back to business. The company is set to report second-quarter earnings, capping what has been a busy half-year for Big Blue and its CEO Ginni Rometty. The immediate question is whether or not it will make its numbers. Analysts expect IBM to report per-share earnings of $4.29 on about $24.1 billion in revenue.

Rometty has promised to deliver $18 a share in earnings this year, on its way toward meeting the big milestone of $20 per share by 2015. Assuming IBM meets expectations today, it will, with half of the year over, have achieved roughly one-third of this year’s target. That will increase the pressure to deliver in the final six months of the year.

The promise of 2015 — one that Rometty inherited from her predecessor Sam Palmisano — is looking more difficult and unlikely every quarter. Hardware sales, which at $57 billion last year accounted for the majority chunk of annual revenue, declined sharply in the first quarter, and have declined at double-digit rates in six of the last seven quarters.

The answer at IBM — following a strategy that it followed over the last decade and change — has been to get rid of less-profitable hardware and invest in more-profitable software and cloud computing. The big move, announced in January, was to sell off the commodity server business to China’s Lenovo in a deal reminiscent of its divestment of the PC business 10 years ago.

Historically, this strategy has worked. Since 2000, IBM has sold off business units worth about $16 billion in annual revenue while more than doubling its profits. When the server sale to Lenovo closes later this year — assuming U.S. regulators don’t scuttle the deal over national security fears — that figure will rise to about $20 billion.

And there has been speculation about more divestments: Numerous published reports say that IBM Microelectronics, its chip-making unit, is close to a sale, and earlier this year Re/code reported that some networking assets are being shopped around as well.

The question is whether or not the new investments will pay off. Last year, IBM spent about $2 billion to acquire SoftLayer, a cloud services company that competes with Amazon Web Services in providing computing services for hire. IBM is now well on its way to spending $1.2 billion more to boost SoftLayer’s data center footprint around the world. It exited 2013 with $4.4 billion in revenue from cloud services and software, making it by that measure bigger than cloud giant Amazon Web Services.

Which brings us back to IBM’s deal with Apple: For all the attention it got as an unlikely combination — Apple and IBM were bitter rivals in the early 1980s when the PC industry was just being born — it’s worth noting that IBM isn’t quite the leader in mobile software that it would like you to think it is.

As Pat Moorhead of the research firm Moor Insights and Strategy noted in a blog post Wednesday, it takes only a casual look at Apple’s App Store to see that IBM’s presence there lags behind that of software rivals Oracle, SAP and Salesforce. All three embraced the iPhone and iPad early and aggressively. Where IBM promises to build 100 iOS apps by next year, Oracle and SAP already have at least that many.

Brian Marshall, an analyst with ISI, put it a little more harshly in a note to clients after news of the deal was announced: “For IBM, we see this as a small step towards restoring relevance among its customer base by specifically focusing on the highest-value applications and use cases in the workplace” that would result in “incremental” software sales over the long-term.

Today’s earnings report obviously won’t include any results stemming from the deal, but expect questions from analysts about what it will mean going forward. Clearly IBM sees an opportunity to step up its software game of selling analytics software businesses, and will happily resell those devices to its corporate customers and help set them up and manage them after the sale is made. It made a psychological difference on Wednesday as reflected in its share price. The longer-term significance is a more complicated story.

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