IBM Looks Cheap Ahead of Earnings, But Growth Still a Concern

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Without question, IBM (NYSE: IBM) is a great company. However, greatness is defined by growth – at least on Wall Street. And this is something that Big Blue has been unable to produce in sufficient quantities. But the company understands this. IBM has been buying up niche companies in an effort to grow – spending $16 billion over the past five years.

Unfortunately, the returns on these investments have not been realized. And investors have grown impatient. But the shares look cheap. Ahead of its Q4 earnings on Tuesday, IBM must prove that it can harvest the value. Then again, seeing how dominant rivals Oracle and have performed, this is a tall task for IBM. But it’s not impossible.

Overcoming Weakness and the Competition

Aside from comparative analysis between Oracle and, IBM’s Q4 will be assessed based on improvements from Q3. Considering how disappointing the results were, to impress the Street, IBM may not have to leap very high. While this might play to its advantage, it also means that expectations are being lowered, which is never a good sign.

In Q3, IBM posted $3.33 in earnings per share on revenues of $24.7 billion. EPS climbing 4.4% was modest. But in a sector ravaged by poor IT spending, it was a win. But it still fell short of analysts’ estimates of $3.61 per share. In the end, that’s what matters. Then again, it didn’t help that revenue declined 5.4% year-over-year.

Making matters worse, it marked the second consecutive quarter of deteriorating sales. Meanwhile, rival Oracle (NYSE: ORCL) was marching to different beat – literally and figuratively. The database giant reported an 18% year-over-year increase in net income – reaching $2.6 billion, or 53 cents per share.

Oracle said profits actually arrived at 64 cents per share when excluding charges related to acquisitions and other costs - enough to beat analysts’ estimates of 61 cents per share. But when compared to (NYSE: CRM) IBM’s numbers appear bleaker. recently posted 35% revenue growth – reaching $788 million.

The performance was helped by better than expected showing in the company’s services support and subscription business, which grew 35% year-over-year. The company continues to grow various business segments such as professional services at an annual rate of over 30% - all of which contributed to an 18% jump in operating income.

Then again, when compared to Oracle’s 3% revenue growth, IBM’s 4.4% stands out well. But in Oracle’s case, it was enough to beat Street estimates by $900 million. However, the most impressive aspect of Oracle’s report was the 17% surge year-over-year in the company’s Software licenses and subscriptions business. While that is still 50% slower than, it is outpacing IBM’s 3% growth in software.

Besides, this was good enough to exceed Oracle’s most bullish projections. Likewise, despite’s strong quarter, management raised the bar - suggesting that the best is yet to come and projecting $4 billion in revenue. In other words, both Oracle and have momentum on their side, while IBM seems sluggish with declining sales.

What to Expect in Q4

As dire as things appear for IBM, the Street is expecting a slight improvement in performance. Average estimates have inched up to $5.27 per share from $5.18, while estimates for the fiscal full year also climbed from $15.01 to $15.13. These projections support the company’s goal of reaching $20 per share by 2015.

In the third quarter report, the company issued EPS guidance of $15.10. I don’t think the company will have any problems hitting this number. But revenue estimates are a different story. That estimates are as $29.66 billion will pose a problem. Then again, the Street will be more focused on 2013 guidance as a sign for how IBM truly feels about its business.

Current 2013 fiscal year estimates calls for $16.63 per share. How IBM guides will weigh on the stock’s direction. Also, profitability will be heavily scrutinized. That the company’s Q3 net income experienced a shortfall, it ended IBM’s streak of year over year profit growth, which spanned four quarters.

Bottom Line

IBM will always be brilliant in my mind. The company saw the decline of PCs a full decade before everyone else and promptly exited the business. Despite the recent substandard performances, the company deserves credit for improved earnings over the past several years, which speaks to an excellent management team.

The company knows what it is up against and realizes what it must do to get back on track. Growth is still a concern. But if the company is able to grow cash flow at a 5% rate over the long term, the stock should be able to approach a fair value of $225 – representing 20% premium. To do that, it might have to make one or two more strategic acquisitions.

rsaintvilus has no position in any stocks mentioned. The Motley Fool recommends The Motley Fool owns shares of International Business Machines. and Oracle.. 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!

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