Annex Bulletin 2011-09                            April 19, 2011

A partially OPEN edition


Big Blue "Rock of Gibraltar" Stands (Analysis of IBM's first quarter business results)


Wall Street's New "Rock of Gibraltar" (Annual update to our 5-yr IBM forecast)



Updated 4/20/11, 8:30PM HST, adds Market Update

Analysis of IBM's First Quarter Business Results

Big Blue "Rock of Gibraltar" Stands

Japanese Earthquakes, Tsunami Leave Big Blue Unscathed, Business Booming in Emerging Markets, Hardware & Software Both Thriving

HAIKU, Maui, Apr 19, 2011 - IBM has just wiped away the fears that a natural disaster may translate into a financial one.   The new Wall Street "Rock of Gibraltar" stands unscathed by the Japanese earthquakes and tsunamis.  Business is booming across the Big Blue geographies and product lines. 

IBM’s Asia-Pacific revenues increased 12 percent (up 4%, adjusting for currency) to $5.9 billion, making this area the company’s best global region.  Even Japan's revenues were up 5% as reported, though they declined by the same amount in constant currency.  But other countries in the region more than made up the slight shortfall.  China, for example, had a terrific quarter, with revenues surging by 36% compared to the first quarter of last year (see the charts).

Furthermore, three-quarters of IBM’s business in Japan is services.  And since services are an annuity, they provide a more stable source of revenues and profits.  As a result, the business in Japan eroded only about 1% in March, according to IBM’s CFO, Mark Loughridge.

"We had some deterioration in March," the IBM CFO told the analysts in the post-earnings release teleconference.  "But it really wasn't that different than we saw through February. So we didn't see a big change in the trajectory of the business."

Overall, IBM reported a fiscal first-quarter profit of $2.9 billion, or $2.31 a share, on revenue of $24.6 billion, up 8%. During the year-ago quarter, IBM earned $2.6 billion, or $1.97 a share, on $22.9 billion in sales. Excluding one-time items, IBM reported operational earnings of $2.41 a share. Wall Street expected IBM to earn $2.30 a share on $24 billion in revenue. The company also raised its 2011 full-year earnings forecast to at least $13.15 a share from $13 a share. 

The market should have breathed a sigh of relief.  Instead, Wall Street worry-warts found new reasons to fret.  After rising in initially in after-market trading immediately following the release of the strong first quarter results, IBM shares dropped about 2% after the teleconference with analysts was over.   

We suspect the main reason is an emotional reaction to IBM’s lower services signings in the first quarter ($10.5 billion, down 15% from a year ago).  Which illustrates Wall Street's relative ignorance about how the services business works.  It is the BACKLOG that tells the tale of future revenues and earnings, not quarterly signings.  And the IBM backlog is still at an all-time high of $142 billion (see the charts).  The running four-quarter average of inflows vs. outflows is actually UP after the first quarter even though the signings were down (see the left chart).  Which is often the case, especially after a huge fourth quarter ($22.1 billion - an all-time record),

So IBM is now playing good defense.  It limited the natural outflow of deals (expirations, cancelations, "rescoping") to the same amount as the new signings.  As a result, the backlog remains as strong as ever. 

Hopefully when common sense returns to Wall Street and emotions yield way to reason, the IBM shares will once again point in the direction the first quarter business results are pushing them - UPWARD!

First Quarter Highlights

IBM also reported for the first time its results on a GAAP and non-GAAP basis for the first quarter of 2011 and 2010: 

    • GAAP: $2.31, up 17 percent;
    • Operating (non-GAAP): $2.41, up 21 percent;
    • GAAP: $2.9 billion, up 10 percent;
    • Operating (non-GAAP): $3.0 billion, up 13 percent;

As to individual segments that contributed to such strong first quarter results, it is hard to pick the best of so many winners…

  • Software revenue excluding divested PLM operations up 10 percent, 8 percent adjusting for currency; 6 percent including PLM, 4 percent adjusting for currency;
  • Systems and Technology revenue up 19 percent, 16 percent adjusting for currency;
  • System z mainframe revenue up 41 percent; MIPS up 34 percent;
  • Services revenue up 6 percent, 3 percent adjusting for currency;
  • Services backlog of $142 billion, up $8 billion;
  • Growth markets revenue up 18 percent, 12 percent adjusting for currency;

Obviously, the mainframe again performed the best, rising 41% from a year ago.  But also, the services backlog surge of $8 billion was even more significant, even if it is "only" $1.5 billion in constant currency.  For, it implies stronger future growth in IBM’s biggest business segment (services accounts for nearly 60% of total revenues - see the chart below).

Also, another double-digit increase in IBM's most profitable segment - software - helped boost Big Blue's both top and bottom lines.  As a result, IBM's operating gross profit margin improved 80 basis points, led by Systems and Software.  The Software pretax income actually declined 18% due to the gain from the sale of PLM last year (right chart).  Adjusted for that, it is actually up 9% (left chart).

"The largest contribution came from hardware, driven by improvements in every systems brand and improving mix," Loughridge said. "We also expanded gross margin in Software, Global Business Services and Global Financing.

Just as the Big Blue demonstrated a remarkable resilience in 2008, when the financial tsunami swept across the U.S. and the world, so it did in the first quarter of 2011, when most of its business segments reported strong growth, notwithstanding the geographic, political and financial turmoil around the world.  Even the Power systems (UNIX servers), which had been down last year, has bounced back.  And software continued to excel at all levels, both in terms of revenues and especially profits. 

As for vertical segments, Financial Services and General Business (SMB - small and medium size business market) both surged in double digits.  Financial was up14% as reported (up10% in constant currency), while the SMB revenues grew 10% as reported (up 8% in constant currency).

The Public sector and Industrial were both down in constant currency (-1% and -4% respectively), though the Public sector revenues were up 1% as reported (see the chart).

Summary & Outlook

Despite some minor blemishes, IBM came sailed through the first quarter with flying colors.   Wall Street doomsayers may be simply letting some steam off a hot stock that has outperformed most of its major rivals so far this year.   Don't expect that to last for long.  Because sooner or later, the value-seekers are bound to be attracted to a "Rock of Gibraltar"-type business which does not yield ground even to earthquakes and tsunamis, let alone to other political or financial disruptions around the world. 

"I don't see anything in the performance in Japan that we should have difficulty dealing with as we go through the year," said IBM's Loughridge, answering a question during the analyst telecon. 

He summed up the quarter by saying, "we're exiting the first quarter with a lot going for us: a strong Systems portfolio, a good pipeline in Software, solid Services backlog, momentum in all our key growth plays and ongoing productivity initiatives, as well as a very strong balance sheet."  Which he felt puts IBM on track for $20 (EPS) in 2015, and at least $13.15 (EPS) for 2011.

As we said, solid like the Rock.

Click here for detailed IBM tables and charts (Annex clients only)

Happy bargain hunting

Bob Djurdjevic

Market Update

HAIKU, Maui, Apr 19, 2011 - The Big Blue doomsayers are yielding to common sense and reason.  The IBM stock is up 2% today to $167.91 as we write this (see the chart below).

No surprise there.  Here's what we told two days ago, right after the first quarter earnings were released:

"...Wall Street doomsayers may be simply letting some steam off a hot stock that has outperformed most of its major rivals so far this year.   Don't expect that to last for long.  Because sooner or later, the value-seekers are bound to be attracted to a "Rock of Gibraltar"-type business which does not yield ground even to earthquakes and tsunamis, let alone to other political or financial disruptions around the world."

So the universe is unfolding as it should.  Cool reason is again winning against fear and negative emotions. As had happened many times before, Wall Street sometimes see the IT world through and upside-down lens.  But eventually it does get it right (see "Upside-Down View," Mar 2005).  Here are some charts from our workshop slides created many years ago...

Guess today is another one of those examples.


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Volume XXVI, Annex Bulletin 2011-09
April 19, 2011

Bob Djurdjevic, Editor

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