What China's Distrust Means for IBM as the Nation Pulls the Plug

NEW YORK (TheStreet) -- Is China really cutting the cord on IBM (IBM)?

IBM has had an expansive reach into China's corporate IT world for over 30 years with its heaviest imprint most notably made in its e-commerce and financial institutions. However, China has been actively urging  state-owned and private entities to move away from IBM servers and services, resulting in domestic rivals winning more contracts and cutting out Big Blue.

The Chinese government's move is largely viewed as retaliatory after the U.S. indicted five Chinese officials for stealing trade secrets. China has been reassessing whether its financial and national security is being compromised by what it deems an unacceptable reliance on IBM technology.

The Ministry of Finance has requested a trial program for certain banks that mandates the inclusion of indigenous servers in lieu of IBM's. This is a troubling development in a market that is supposed to be one of IBMs greatest generators of growth. IBM shares closed Thursday at $180.37, down nearly 4% for the year to date.

IBM has had eight consecutive quarters of revenue decline. China is not helping matters with revenue within the country falling a precipitous 20% or greater over the last two quarters.

The Chinese distrust has been going on a while, too. Back in 2013 China Economic Weekly ran an article, He's Watching You that singled out IBM among other U.S. tech firms, as "guardian warriors" and a potential threat to Chinese economic and national security. These warriors have struggled within China ever since.

Last year 14% of IBM's $99.8 billion in revenue  -- the first time its failed to surpass $100 billion since 2010 -- originated from the Asia-Pacific region, excluding Japan. Nearly 10% of total revenue is derived from its server business. Several analyst estimates have concluded that approximately 4 % of total revenue originates from China, or roughly $4 billion. So while this does not shake the entire foundation of the company by any means, it is not an insignificant sum for a corporation that can't increase revenue to save its life lately.

This switch by China isn't exactly happening by next weekend as the overhaul will carry a substantial price tag and new technology implemented will need to meet the security and reliability standards demanded from financial and banking institutions. A recent survey by the National Development and Reform Commission (NDRC) showed that less than 2% of IT equipment at Chinese firms were created by Chinese companies.

So, in short, this move will be glacial -- 20 years is the predicted amount of time it would take to effectively remove IBM's stamp from  China's tech infrastructure, if it's so inclined to remove it. In the interim, however, you can expect to continue to see cutbacks in IBM's business in this country.

The author has no position in any of the stocks mentioned.

Follow Jason @https://twitter.com/JasonOrestes

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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TheStreet Ratings team rates INTL BUSINESS MACHINES CORP as a Buy with a ratings score of B+. TheStreet Ratings Team has this to say about their recommendation:

"We rate INTL BUSINESS MACHINES CORP (IBM) a BUY. This is driven by a number of strengths, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its notable return on equity and expanding profit margins. We feel these strengths outweigh the fact that the company has had sub par growth in net income."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • Current return on equity exceeded its ROE from the same quarter one year prior. This is a clear sign of strength within the company. Compared to other companies in the IT Services industry and the overall market, INTL BUSINESS MACHINES CORP's return on equity significantly exceeds that of both the industry average and the S&P 500.
  • The gross profit margin for INTL BUSINESS MACHINES CORP is rather high; currently it is at 52.66%. It has increased from the same quarter the previous year. Regardless of the strong results of the gross profit margin, the net profit margin of 10.60% trails the industry average.
  • INTL BUSINESS MACHINES CORP's earnings per share declined by 14.8% in the most recent quarter compared to the same quarter a year ago. This company has reported somewhat volatile earnings recently. But, we feel it is poised for EPS growth in the coming year. During the past fiscal year, INTL BUSINESS MACHINES CORP increased its bottom line by earning $15.02 versus $14.41 in the prior year. This year, the market expects an improvement in earnings ($17.89 versus $15.02).
  • Despite the weak revenue results, IBM has outperformed against the industry average of 16.6%. Since the same quarter one year prior, revenues slightly dropped by 3.9%. Weakness in the company's revenue seems to have hurt the bottom line, decreasing earnings per share.
  • Net operating cash flow has decreased to $3,326.00 million or 17.32% when compared to the same quarter last year. Despite a decrease in cash flow of 17.32%, INTL BUSINESS MACHINES CORP is in line with the industry average cash flow growth rate of -20.41%.

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