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And Now on to Next Phase for “Big Blue” Under Gerstner: How to Grow IBM?  Make It Smaller, Better!

Break Up IBM!

A Blueprint for a $180 IBM Stock: Spinning-off and Selling-off Certain Businesses Could Generate $43 Billion of Additional Shareholder Value

PHOENIX - In the just-released IBM 1995 Annual Report, Lou Gerstner asks a rhetorical question in his letter to the shareholders:  “So now what?  Now that our financial foundation is again strong, now that we are growing, now that we seem to have some momentum - what’s the next mountain?”

Gerstner answers his own question:  “Which brings me to the V-word.”

The V-word?

The “vision statement.”  Remember back in 1993 what Gerstner said that “the last thing IBM needs right now is a vision?” 

Well, if you’ve forgotten, the IBM chairman will remind you in the Annual Report.  “It’s with enormous sense of irony that now, almost three years later, I say this: What IBM needs most right now is a vision.”  So there you have it - right from the “horse’s mouth.” 

We’ve told you that Gerstner’s March 4 appearance before the financial analysts was his “Vision II” statement (see ANNEX BULLETIN 96-15, 3/04/96).  Now he has also confirmed it.  For a comparison between IBM chairman’s “Vision I” (Mar. 1994) and “Vision II” (Mar. 1996), see the table on this page.

But neither the Gerstner “Vision I” nor his “Vision II” addressed the issue of how to increase the shareholders’ value.  Of course, the implication is that the shareholder returns would also rise if IBM provides added value to customers.  But that’s far from certain.  

For example, a company could literally give away some or all of its technology or services - a questionable practice, but one which is increasingly becoming popular. Think Internet, if in doubt.  This could make the customers deliriously happy, while the company’s shareholders cry in their soup.  So it will take more than just pleasing the customers to provide the badly needed growth of IBM’s market value.  One solution is to make IBM smaller. 

Make it smaller to boost its value?


There are plenty of examples in nature to support this view.  An amoeba splits up, for example, it order to perpetuate life.  Vegetation at the site of a forest fire is always richer than it was before the fire.  But we don’t have to stray too far afield to make the same point in business.  Sometimes the sum of the parts can be greater than the whole (company). 

AT&T’s chairman, Bob Allen, evidently thought that when he announced a voluntary break-up of the U.S. telecom giant last September.  And the stockmarket agreed, propelling the AT&T stock seven points (12%) following the declaration.

Two years earlier, in September 1993, Gerstner, reversed John Akers’ break-up plan.

So who is right?  Allen or Gerstner?

Could the AT&T logic also apply to IBM?

It could.  If done judiciously.  Which means not the way Akers had envisaged it in 1991-1992. 

The upshot of a well thought out and executed IBM break-up could be a $43 billion bonanza for its shareholders.  It would lead to a smaller and a bigger Big Blue - smaller in revenue (about $46 billion) and bigger in market value (about $103 billion). 

Blueprint for a $180+ IBM Stock

What follows is our blueprint for how to get the IBM stock back to the $180+ level and beyond; how to restore it to its old glory when it was a bellwether stock of the New York Stock Exchange; and how to make it again the world’s most valuable corporation.

So what would it take?

In short, it will take a leader with courage and humility, not just vision, to make this blueprint a reality.  And here’s why...

 “Crown Jewels.”  One of the reasons for IBM’s increased profitabilty is its services business, by far the biggest contributor to IBM’s net profit!  We estimate that IBM global services (meaning maintenance and other services), dropped about $1.8 billion to Big Blue’s 1995 bottom line.  The next biggest contributor was the S/390 division, which added about $1.2 billion to IBM’s earnings.  The AS/400 sent over $600 million to the bottom line.  Finally, the non-OS IBM software and the RS/6000 pitched in with about half a billion of net profit each.

These five operations are IBM’s “crown jewels.”  If valued as separate companies with shares priced in line with their leading competitors, the “five IBM musketeers” would likely be worth double the value of the entire Big Blue on Jan. 18 - the day its 1995 results were announced!

One reason the IBM services business is so successful is that the company reorganized itself into industry-based units in May 1994.  This bold move, the most radical restructuring in IBM’s corporate history, finally earned Gerstner an “A” on our score card.  He may get an “A+” if he makes Wall Street see what the customers already know - that the best of the “new IBM” isn’t its “iron;” that there is plenty of hidden value for those able to look under the hood.

In 1996 to-date, for example, the IBM stock has traded between about $83 and $129, implying an average price/earnings (P/E) ratio of 15, and a price/revenue (P/R) ratio of 0.81.  Since ISSC/IBM Global Services are indistinguishable to investors from the rest of IBM, the above P/E and P/R ratios apply to them, too.

At the same time, however, the shares of publicly traded ISSC competitors - EDS and CSC - which have not done nearly as well as ISSC/IBM services - have been trading at P/E ratios of 28.5 and 32.5, and P/R ratios of 1.18 and 1.05 respectively. 

Clearly, the preceding means that the implied market value of ISSC/IBM Global Services is understated because of its association with IBM’s less successful and profitable businesses, and a lack of individual services identity.

How much money is IBM leaving on the table as a result?

It could be up to $28 billion on account of just the IBM global services alone!  If all IBM “crown jewels” were added together, using similar peer-based P/E or P/R multiples, their aggregate value would be almost $103 billion - some $43 billion more than the value of the entire IBM, based on its average 1996 stock price. 

And the stock price of an IBM consisting of just its five “crown jewels” would be over $180 per share, as compared to the average 1996 price of $106 per share.  An IBM like that would be a smaller company ($46 billion vs. $72 billion revenue), but evidently a much better operation.

There is not much doubt, therefore, that such a smaller, nimbler IBM would mean increased market value.  But just exactly how should Gerstner do it to maximize the return to shareholders?

Six Steps to Riches: How Should IBM Be Split Up?

Step 1: Spin off and report separate financial results for the IBM Global Services, including the Integrated Systems Solutions Corp., its outsourcing subsidiary, as well as maintenance.

Step 2: Sell the PC Division and the other low-margin hardware operations, such as OEM, and/or other low-margin hardware products.

Step 3: Consolidate the remaining high-margin product businesses - S/390, AS/400 and RS/6000 into a single IBM Server company.  It should include the respective OS software (OS/390, OS/400 and AIX).

Step 4: Evaluate the feasibility and desirability of spinning off the non-OS software into a separate business, such as the network-related (Lotus+), or other IBM software (e.g., middleware; VisualAge, systems management tools/Tivoli, etc.).

Step 5: Aggressively market the new IBM market value proposition - “smaller is better” to some Wall Street “stoneagers.”

Step 6: Increase the IBM dividend as the financial benefits rise (i.e., the shareholders’ value).

What Would It Take?

What would it take for Gerstner to make our six-step blueprint a reality?

Courage and humility. 

Courage - because he would have to act more boldly than any other IBM chairman since Tom Watson’s (Jr.) S/360 project (in the early 1960s). 

Humility - because Gerstner would have to give up the empire-building, and concentrate on creating wealth for the shareholders, including himself, of course.

Does Gerstner Have What It Takes?

Does Gerstner have the courage and the humility to do it?

A year ago, we would have said “probably not.”  But based on his recent performances, including his passionate “thank you” tribute to IBM employees in the 1995 Annual Report, we’d put the odds at better than 50/50.  After all, at a $180 stock price, he’d probably have more to gain than most IBM employees.

Happy bargain hunting!

Bob Djurdjevic

Additional Media Coverage of This Annex Bulletin

Volume XII, No. 96-19
March 20, 1996

Editor: Bob Djurdjevic
Published by Annex Research
e-mail: annex@djurdjevic.com

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