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Analysis of IBM’s 2002 Annual Report

Shrunk by the Marketplace

What Former CEO Thought Was a “Dumb Idea,” the Marketplace Is Now Doing to Big Blue; IBM’s Pension Plan Woes Continue…

PHOENIX, Apr 17 - Over seven years ago now, we proposed to the former IBM CEO, Lou Gerstner, that he break up and shrink the Big Blue if he is to achieve the kind of growth Wall Street was expecting (see "Break Up IBM!", Mar 20, 1996).  Here are headlines from that report:

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

Gerstner thought it was a “dumb idea” (see “Louis XIX of Armonk,” Aug 1996).  Over the next six years, he chose to squander nearly $50 billion on stock buybacks instead of investing in acquisitions and new products and services, and divesting the loser units.

Well, the marketplace is now doing to IBM what the former CEO didn’t have the foresight to do.  It is downsizing the company.  IBM’s 2002 Annual Report, released last month, revealed that Sam Palmisano’s Big Blue of 2002 was about the same size as Gerstner’s IBM was five years ago ($81.3 billion in revenues). 

Ever since 1999, the year we said Gerstner’s best years were behind (see "Gerstner: Best Years Are Behind", Aug 1999), IBM has been “growing” by shrinking.  Which is another sad legacy of its former CEO (also check out “Gerstner’s Legacy: Good Manager, Poor Entrepreneur”, Jan 2002).

As you have seen from our last two Annex Bulletins on IBM, Big Blue’s new leader and his lieutenants have been trying to reverse the damage Gerstner has inflicted on IBM shareholders (see “Turnaround Continues...”, Apr 15 and “Start of a Real Turnaround?”, Jan 17).  But they have a long way to go.  Just how long can be seen, from continued woes of the IBM pension plan, and from ongoing problems with IBM’s PC and Technology units - two IBM business units we said back in 1996 that Gerstner should sell (see Step 2 below):


Our report then goes on to describe our 1996  recommendations, and analyze and contrast in detail the performance of various IBM business units based on the latest information discernible from the IBM 2002 Annual Report.  There is also a special section on the IBM pension plan shortages.

Segment Analysis

Personal Systems.  Back in 1996, the PC division was a $14 billion business.  In 2002, it was an $11 billion-operation, on its way to $10 billion or less per year, after having peaked at $15 billion in 1998.

Despite having been shrunk by the marketplace, this IBM unit may actually seem fairly impressive judged by its bulk alone.  During the last 10 years (1992-2002), it contributed about $150 billion in revenues to IBM’s top line.  

Unfortunately for IBM shareholders, it has also been a money-losing operation for most of those years, sometimes to the tune of $1 billion or more per year.  Which is why we recommended that Gerstner sell it.


Technology. The IBM Technology division is another money-losing unit that we suggested back in 1996 that Gerstner ought to shed.  He didn’t.  So the losses kept mounting… a few hundred million one year, a few hundred next.

Finally, last year, his first at the Big Blue helm, IBM’s new CEO took some action.  Palmisano sold the (hard disk) part of this unit to Hitachi.  The resulting $1.2 billion Technology pretax loss in 2002 should serve as a good reminder about how important timing is in everything.  It makes it seem almost as if IBM paid Hitachi to “buy” this operation from Big Blue.  Seven years ago, when hard disk storage was still a profitable business, it would have been an entirely different story.


Global Services.  IBM Global Services (IGS) unsurprisingly accounted for the largest share of IBM’s revenues in the last 10 years - $303 billion or 34% of the total. 

In the latest full year (2002), IBM’s only “crown jewel” of the 1990s accounted for $36 billion or 45% of the total, up 8% from the year before.  Both sets of figures include maintenance revenues.

Led by a surge in outsourcing in the mid-1990s, IBM services (excluding maintenance) also topped all other segments in terms of growth.  Outsourcing grew at 19% compounded annually in the last five years (1997-2002), while the overall services revenues increase at 8% per year during the same time frame.


Enterprise Systems.  IBM Enterprise Systems, now renamed to just ”Systems,” was the second largest segment in the last 10 years.  Its aggregate revenues of $175 billion represented 20% of IBM’s total during that period.  Unfortunately for IBM, this segment has also been shrinking throughout the period at a rate of 3% compounded annually.


Software.  The IBM Software unit was the third largest revenue contributor in the 1992-2002 period, with a $166 billion, or 19% of total.  Unfortunately for IBM, this stellar performer from the 1980s, that regularly chalked up growth rates of 20% to 30% per year back then, stalled in terms of its growth in the last 10 years.  The compound annual growth of software revenues was only 2% during the last 10 years.


Summary.  The only IBM real growth segment in the 10 years has been the IBM Global Services operation.  Yet even that unit, despite an outstanding sales record in 2000-2002, has dropped down to only a single digit revenue growth rate. 

In short, Gerstner’s IBM was worse than even John Akers’ growth record.


Pension Fund Woes

One year ago, in a story about IBM’s sudden pension fund deficits, we wondered “Where Did $17 Billion Go?” (Mar 21, 2002).  This year, however, the same question would have read: “Where did $24 billion go?”

Yes, for the first time ever, both IBM U.S. and non-U.S. pension plans are under water - to the tune of $6.4 billion (the amount by which the obligations exceed the pension fund assets).  Of that total, $1.4 billion is attributable to the U.S. plan, with the balance ($5.1 billion) representing the non-U.S. shortages.  Yet at the end of 1999, the two sets of plans yielded a $17.2 billion surplus (of assets over obligations).  That’s a $24 billion downward swing in just three years!


"That's all she wrote," we're afraid, for those of you who are NOT Annex Research clients, and who are now reading the complete Annex Bulletin (12 pages in print edition), along with all charts which back up our story.

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Happy bargain hunting!

Bob Djurdjevic

For additional Annex Research reports, check out... 

2003: “Turnaround Continues...” (Apr 15), “Start of a Real Turnaround?” (Jan 17).

2002: “Gerstner: The Untold Story”  (Dec 27), "Gerstner Spills the Beans" (Dec 13), "On a Wing and a Prayer" (Oct 21), "IBM-PwC Tie the Knot" (Oct 2), "Half or Double Trouble?" (Aug 12), Wall Street/Main Street Chasm (June 25), “Wall Street Casino,” (June 21), Big Blue Salami (June 19), "Looming IBM Layoffs" (May 14), "IBM 5-Yr Forecast: From Here to Eternity?" (Apr 2002),  “Tough Times, Soft Deals,” (Apr 25, 2002), “Gerstner’s Legacy: Good Manager, Poor Entrepreneur” (Jan 2002), IBM Pension Plan Vapors: Where Did $17 Billion Go? (Mar 2002), "Sir Lou OutLayed Lay!" (Apr 1, 2002).

A selection from prior years: Is IBM Cheating on Taxes, Annex Bulletin 99-17 (May 1999),  IBM 5-year Forecast 2001: An Unenviable Legacy (June 2001) "Break Up IBM!" (Mar. 1996), Fortune on IBM (June 15, 2000), “Smoke and Mirrors Galore,” July 2000), "Slam Dunk of Bunk" (Jan 2000), Annex Bulletin 98-14 ("Wag the Big Blue Dog"), Armonk's Fudge Factory (Apr. 9, 1999)Where Armonk Meets Wall Street, Greed Breeds Incest (November 1998)Stock Buybacks Questioned: Is IBM Mortgaging Its Future Again?, 97-18 (4/29/97),  "Some Insiders Cashed In On IBM Stock's Rise, Buybacks" 97-22, 7/27/97,  Djurdjevic’s Forbes column, "Is Big Blue Back?," 6/10/97;  “Executive Suite: How Sweet!,” (July 1997), "Gerstner: Best Years Are Behind", Aug. 10, 1999), "IBM's Best Years Are 3-4 Decades Behind Us" (July 1999), "Lou's Lair vs. Bill's Loft" (June 1999),  "Corporate Cabbage Patch Dolls," 98-39, 10/31/98; Djurdjevic’s Chronicles magazine October 1998 column, "Wall Street Boom; Main Street Doom", “Louis XIX of Armonk,” (Aug. 1996), "Mountain Shook, Mouse Was Born" (Mar. 25, 1994), “A Nice Guy Who Lost His Compass” (Jan 26, 1993), “Akers: The Last Emperor?” June 1991), Industry Stratification Trend (Mar. 30, 1990) etc.]

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Volume XIX, No. 2003-07
April 17, 2003

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

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