Consumer & Business Computing/IT: A Perplexing World For Investors

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

There is a growing division between consumer-oriented and business-oriented computing and information technology companies. Many firms are targeting business clients, particularly those in cloud computing and networking. This would be great if there were not many desperate companies vying for this market, and if large companies didn’t try to make inroads into this new territory by making acquisitions. However, since there is fierce competition in this space, investors should demand low valuations while avoiding firms that perpetually make acquisitions. I will examine IBM (NYSE: IBM) and Brocade (NASDAQ: BRCD) in this context to see if they meet this criteria. I will also compare them to Hewlett-Packard (NYSE: HPQ), which has been struggling in its core business areas.

Good Forecasts, Except for the Acquisitions

IBM shares rose after the company declared its forecast for 2013, which exceeded analyst estimates. According to the company, the earnings in 2013 will be at least $16.70 per share. The earnings estimate is above the $16.64 average estimate of the analysts that are tracked by Bloomberg.

Ginni Rometty has pushed for a transition in the business strategy during her first year as the Chief Executive Officer of the company. Currently, the business focuses on more profitable venture such as software for data analysis, moving away from hardware, which is becoming a commodity product. Currently, the company expects to earn $20 per share by 2015. She has placed a five-year plan to draw the largest profit possible from software by 2015.

According to Josh Olson, an analyst at Edward Jones, “She had some big shoes to fill, and expectations were very high. This could be characterized as an adjustment year, one where she is mapping her course, and it’s largely been similar to what we’re used to from IBM.”

Last year, Rometty divested the retail hardware business, purchased data analysis providers and software, and added new technology to assist clients in accessing data from remote computers through cloud computing. The company is also focusing on squeezing out greater revenue from its consulting contracts by looking for better deals in emerging markets.

According to David Grossman, an analyst with Stifel Nicolaus, the company is continuously evolving its strategy and is focusing on balancing its mature business that generates cash with more promising new markets, such as analytics.

The company’s fourth quarter income, excluding certain items such as amortization and pension costs, increased to $6.1 billion, or $5.39 per share. Sales slipped by 1% to $29.30 billion, but came in above the average estimate of $29.10 billion of 21 analysts. The company reported revenue of $104.50 billion for 2012, and analysts anticipate revenues will grow to $106 billion for 2013. During the quarter, the company’s services backlog from various contracts reached $140 billion, compared to $138 billion in the third quarter.

According to Chief Financial Officer Mark Loughridge, sales of the Global Business Services will improve this year after a 4% decline to $18.6 billion in 2012. This is the consulting unit of the company.

Last year the company’s acquisitions totaled $3.7 billion for 11 companies, including $1.3 billion for Kenexa, a company that uses social networking to assist businesses that handle human resources and recruiting. The company also plans to spend $20 billion on acquisitions between 2011 and 2015. Since acquiring companies often overpay for their targets, this is bad news.

Brocade not Actively Selling

Lloyd Carney, CEO of Brocade Communications Systems, denied that he is trying to sell the company. This is in contrast to the company’s previous CEO, Mike Klayko, who had looked for a buyer.

Mr. Carney was appointed as the Chief Executive officer of the company in January, 2013. Previously, he served as the CEO of Xsigo Systems, which was acquired by Oracle. Earlier he led Micromuse, which was later acquired by IBM in 2006. He served at Xsigo Systems for five years and Micromuse for three years before they were acquired. Klayko’s resignation was seen as a step by the board of directors to speed up the sale of the company since Mr. Carney has sold multiple firms under his control.

The company had appointed Frank Quattrone, a technology investment banker, to look for buyers.

According to Carney, “This is not a short-term proposition. If someone shows up with stupid money, I have to listen to it. But my history is I’m not a quick-turn guy. I’ve never done that.” He also described the company as a standalone player

Even though the company has good cash flows and well-known market position, it still has not found a suitable suitor in the past three years. Investors should not think of Brocade as a slam dunk pre-takeover buy, but as just a firm with ongoing operations.

Financial Metrics

Let’s consider business-oriented technology firms by ordering them by market cap:

<table> <tbody> <tr> <td> <p><strong>Ticker</strong></p> </td> <td> <p><strong>Company</strong></p> </td> <td> <p><strong>Market Cap ($Millions)</strong></p> </td> <td> <p><strong>P/E</strong></p> </td> <td> <p><strong>P/S</strong></p> </td> <td> <p><strong>P/B</strong></p> </td> <td> <p><strong>P/FCF</strong></p> </td> <td> <p><strong>D/E</strong></p> </td> <td> <p><strong>Growth Next 5 Years</strong></p> </td> </tr> <tr> <td> <p><span>IBM</span></p> </td> <td> <p><span>International Business Machines</span></p> </td> <td> <p><span>231,319</span></p> </td> <td> <p><span>14.74</span></p> </td> <td> <p><span>2.21</span></p> </td> <td> <p><span>10.74</span></p> </td> <td> <p><span>19.44</span></p> </td> <td> <p><span>1.56</span></p> </td> <td> <p><span>9.9%</span></p> </td> </tr> <tr> <td> <p><span>CSCO</span></p> </td> <td> <p><span>Cisco Systems</span></p> </td> <td> <p><span>109,477</span></p> </td> <td> <p><span>13.3</span></p> </td> <td> <p><span>2.35</span></p> </td> <td> <p><span>2.08</span></p> </td> <td> <p><span>12.77</span></p> </td> <td> <p><span>0.31</span></p> </td> <td> <p><span>9.4%</span></p> </td> </tr> <tr> <td> <p><span>EMC</span></p> </td> <td> <p><span>EMC</span></p> </td> <td> <p><span>51,676</span></p> </td> <td> <p><span>20.11</span></p> </td> <td> <p><span>2.43</span></p> </td> <td> <p><span>2.38</span></p> </td> <td> <p><span>9.56</span></p> </td> <td> <p><span>0.08</span></p> </td> <td> <p><span>13.6%</span></p> </td> </tr> <tr> <td> <p><span>HPQ</span></p> </td> <td> <p><span>Hewlett-Packard</span></p> </td> <td> <p><span>33,138</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.28</span></p> </td> <td> <p><span>1.49</span></p> </td> <td> <p><span>5.66</span></p> </td> <td> <p><span>1.27</span></p> </td> <td> <p><span>2.2%</span></p> </td> </tr> <tr> <td> <p><span>JNPR</span></p> </td> <td> <p><span>Juniper Networks</span></p> </td> <td> <p><span>10,972</span></p> </td> <td> <p><span>60.8</span></p> </td> <td> <p><span>2.52</span></p> </td> <td> <p><span>1.55</span></p> </td> <td> <p><span>33.18</span></p> </td> <td> <p><span>0.14</span></p> </td> <td> <p><span>13.3%</span></p> </td> </tr> <tr> <td> <p><span>PANW</span></p> </td> <td> <p><span>Palo Alto Networks</span></p> </td> <td> <p><span>3,826</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>13.47</span></p> </td> <td> <p><span>16.25</span></p> </td> <td> <p><span>59.79</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>50.0%</span></p> </td> </tr> <tr> <td> <p><span>RVBD</span></p> </td> <td> <p><span>Riverbed</span></p> </td> <td> <p><span>2,915</span></p> </td> <td> <p><span>45.1</span></p> </td> <td> <p><span>3.63</span></p> </td> <td> <p><span>3.91</span></p> </td> <td> <p><span>13.03</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>20.9%</span></p> </td> </tr> <tr> <td> <p><span>BRCD</span></p> </td> <td> <p><span>Brocade</span></p> </td> <td> <p><span>2,600</span></p> </td> <td> <p><span>13.9</span></p> </td> <td> <p><span>1.16</span></p> </td> <td> <p><span>1.17</span></p> </td> <td> <p><span>5.02</span></p> </td> <td> <p><span>0.27</span></p> </td> <td> <p><span>9.8%</span></p> </td> </tr> </tbody> </table>

The top four companies on this list are big enough that they have historically engaged in many acquisitions, or could do so in the future. This is a knock against them as buy candidates. Hewlett-Packard and IBM have D/E ratios over one, which indicates that they are funded more by liabilities than by ownership. This is the rule of thumb which many value investors use to avoid companies with high leverage. These issues do not bode well for stock investors.

Another negative for HP is the recent ruling that has been denied a court order to depose former workers who quit to work at General Motors' new tech facility in Austin, Texas. In December, HP demanded answers from former employees about a planned "mass exodus" of 18 workers to the new GM facility. 

Among the smaller companies, Brocade is very attractive. It trades near the accounting value of its assets (P/B ratio of 1.17), which is a steal for tech companies. It has a low level of debt, a reasonable P/E ratio, and it is small enough to attract “stupid money” from potential acquirers. Brocade is a good buy candidate for business-oriented tech firms.


BillEdson11 has no position in any stocks mentioned. The Motley Fool owns shares of International Business Machines.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus