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IBM’s Business Remix Pays Off

Posted on Tuesday, Apr 20th 2010

Over the past decade, IBM (NYSE:IBM) with annual revenue of $95.8 billion, has followed a smart strategy by exiting low-margin “commoditized” businesses and focusing on higher margin software and services. Yesterday the company reported a 13% increase in its first quarter profit and raised its outlook for the rest of the year. Let’s take a closer look.

According to a recent report, IBM is the market share leader for service-oriented architecture (SOA) software, capturing nearly 75% of the market and 31% of the overall middleware market. IBM’s share has been boosted by many Oracle customers switching to IBM. About 450 companies switched to IBM from Oracle last year. In 2008, Oracle introduced its Fusion Middleware roadmap that combines features from various acquisitions, including BEA and Plumtree. But its customers have complained that only some of the new product features have been delivered while prices were raised. They find IBM to be a cheaper alternative.

IBM has recently announced a new range of integrated systems for large-scale data analysis to challenge Oracle’s Exadata platform. Exadata was first launched in partnership with HP, but Oracle lauched a second version with Sun as its hardware partner.

IBM reported first quarter revenue of $22.9 billion, up 5%. Net income increased 13% to $2.6 billion. EPS was $1.97 per share, up 16% and beating analyst expectations of $1.93 on revenue of $22.75 bilion. Q4 analysis is available here.

Gross profit margin was slightly below expectations at 43.6% but improved 0.2 percentage points. IBM ended the first-quarter 2010 with $14.0 billion of cash on hand and debt of $26.3 billion, up from $26.1 billion at the end of 2009. The company returned $4.7 billion to shareholders through $0.7 billion in dividends and $4.0 billion of share repurchases.

IBM CEO Samuel J. Palmisano said, “In the first quarter, we drove significantly improved revenue growth rates from the fourth quarter across our businesses and geographies. We had strong results in strategic investment areas including growth markets, business analytics and Smarter Planet solutions.”

Software revenue was up 4% and Systems and Technology revenue up 5%. Software signings were $12.3 billion, down 2% that include 13 contracts greater than $100 million. What is worth noting in its earnings is the increase in consulting signings. Consulting services signings increased 18% and Strategic Outsourcing signings by 6%.

Based on its performance, IBM has raised its 2010 profit target to at least $11.20 from the previous outlook of at least $11. Analysts expect full-year EPS of $11.12. The stock is currently trading around $132 with market cap of about $172 billion. It hit a 52-week high of $134.25 on January 19. IBM shares plunged 3% in after-hours trading as investors were disappointed with the 2% decline in software signings.

Edward Jones analyst Andy Miedler said, “IBM’s shares have been particularly strong over the past week with investors anticipating the strong results, so there could be some near-term profit taking.”

Last quarter, despite some recovery in IT spending, IBM’s consulting sales hadn’t yet picked up, but the latest results show that its remix is paying off. It was just a matter of time; the company’s strategy is solid.

Chart for International Business Machines Corp. (IBM)

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