Big Blue’s Software Machine
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IBM (NYSE: IBM) sustained its nearly decade-long earnings streak as it shook off the economic jitters of Europe and ignored the implosion of Spain that have undercut several other technology companies. Earnings rose 6% in their latest quarter, despite a 3% drop in revenue. This was the 38th consecutive quarter that IBM's net income has climbed year over year. That IBM did this as former bitter rival (and business partner) Microsoft posted their first-ever quarterly loss in 26 years is close to the very definition of irony.
The achievement comes after tech companies such as Advanced Micro Devices (NYSE: AMD), Informatica, Intel (NASDAQ: INTC) and Lexmark International have blamed rising fears about a recession resulting from the Euro-crisis and slowdown in Asia on this quarter’s disappointing results with further lowered guidance coming for Q3. IBM’s encouraging bottom line is the result of increased focus on sales of software and technology services, two businesses with higher profit margins than computer equipment that had provided the company's financial backbone through most of its 101-year history.
Getting Soft to Run Hard
Big Blue doesn’t sell nearly as much big silicon as it used to.
And it is one of the hallmarks of IBM’s ability to reinvent itself every generation or so, successfully navigating the changes in technology. From typewriters to servers and PCs and now to backbone solutions and enterprise software solutions, IBM’s history has had one common theme running through it -- providing businesses with the tools they need to increase their organizational capacity.
Software and technology service are the two divisions within IBM generating the highest margins and are increasingly providing a bigger slice of the earnings pie. For the quarter ended June 30, software accounted for 42% of total profit and it is IBM’s expectation that this will rise to more than 50% by 2015. Sporting gross margins above 88%, this is not hard to see, especially considering it was the only division whose revenue and income did not decline this past quarter. To implement this and trim in other non-performing areas, they will significantly add to their software sales staff in the U.S.
As a part of its strategy to focus on software sales, it completed the acquisition of Varicent Software, a leading provider of analytics software for compensation and sales performance management.
Even hardware specialists such as Hewlett-Packard (NYSE: HPQ) and Dell (NASDAQ: DELL) are following IBM on selling software and services to corporate and government customers as they both realize that selling commodity hardware is not the path to the future. H-P’s strategy has to revolve over their contextual search product Autonomy while Dell’s plan is to focus on leaning out SMEs and getting them to the cloud, picking up what IBM and H-P leave behind.
Building Asian Infrastructure
Quarterly revenues slipped in most of the regions including the US and Europe. Revenues from Europe, West Asia and Africa declined nine percent to $7.9 billion, while that from the Asia-Pacific climbed two percent to $6.3 billion. Revenues from BRIC countries — Brazil, Russia, India and China — increased 5 percent (up 12 percent, adjusting for currency). The strong U.S. dollar cost IBM nearly $1 billion in revenue from emerging markets.
In China, IBM is helping to transform the Zhenjiang city’s public transportation system. Zhenjiang will use hardware, software, services and technologies from IBM's Research labs.
Something that IBM doesn’t make a big deal out of, thanks to the increasingly cancerous rhetoric over the U.S. unemployment situation, is that IBM employs more than 100,000 people in India. This is something that IBM will not admit publicly, that it employs such a large number of people in India.
Growth markets in general were responsible for the majority of IBM’s growth in FY 2011 and will continue. Adjusted for currency conversion major markets like the U.S. and the E.U. accounted for only 1.6% of the growth in revenue as opposed to the 16.1% growth in the BRIC nations.
Confident about the future, IBM has raised its adjusted-earnings forecast for the full year to $15.10 a share, one of the few Dow components to do so so far this earnings season. Such optimistic forecasts come from their use of multi-year contractual agreements for their services, a model that Microsoft is finding a ton of success with for its enterprise software. IBM ended with about $136 billion in contract "backlog," which is expected to convert into revenue in future quarters. That includes $13.7 billion worth signed during the most recent quarter.
IBM has underperformed the S&P 500 so far this year after accounting for more than half of the Dow Jones rise in 2011, which IBM has been trading right in line with. The current price near $190 puts Big Blue trading at a multiple of 14.3 and a forward multiple of 12.8, paying a 1.8% dividend. With their further pushing the software envelope that should continue to drive improved net margins especially into the developing markets where they are seeing their best growth.
In the short term I would attenuate any revenue expectations however until such time that the Federal Reserve ends its current tightening cycle. What the strong dollar taketh away it can just as easily give back in a quarter or two.
PeterPham8 has no positions in the stocks mentioned above. The Motley Fool owns shares of International Business Machines, Intel, and Microsoft. Motley Fool newsletter services recommend Intel and Microsoft. 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. If you have questions about this post or the Fool’s blog network, click here for information.
