Annex Research| Annex Bulletins| Index 2003 | SearchFeedbackClips| Activism| Quotes|
The copyright-protected information contained in the ANNEX BULLETINS is a component of the Comprehensive Market Service (CMS). It is intended for the exclusive use by those who have contracted for the entire CMS service.

   Confidential Annex Research Client Edition

IT SERVICES

Analysis of IBM Global Services’ 2002 Business Results

Investing in Growth

Net Drops Due to PwCC Acquisition Expenses; Gross Margins Steady; “As IBM’s Profit Dropped, IGS’ Importance Rose”

PHOENIX, Apr 30 - Despite the severe challenges IBM Global Services (IGS) faced in the 2002 marketplace, especially in the first half, especially with its large accounts (see Analysis of IGS 2001 Results, Apr 26, 2002), Big Blue’s “crown jewel” chalked up a respectable revenue growth last year (+4% to $31.3 billion[1]).  Credit IBM’s $3.5 billion mid-2002 acquisition of PricewaterhouseCoopers Consulting (PwCC) for most of it.  We estimate that PwCC contributed more than $1 billion in additional revenues to the IGS annual total (see IBM-PwCC Update, Oct 2, 2002). 

But the expenses associated with the acquisition also caused a net profit decline of 9% (to $2.1 billion).  Nevertheless, with a 7% net margin, the world’s largest IT services company is still likely to be a stellar performer in our annual Global IT Services Heptathlon, whose results are due next month.  That’s because most of IGS’ largest competitors have been mired in problems of their own, in addition to those caused by sluggish economies in the developed world. 

The IGS gross margins have also held steady - at about 24% - despite a plethora of “megadeals” the company has won lately.  That was no small feat, either, given that “the hotly contested ‘megadeals’ are often like the game of chicken: The last bidder to say ‘no’ gets stuck with the deal,” as we put it in the Annex Bulletin 94-46 (10/19/94).

“Crown Jewel”

As our longtime clients may recall, we have been referring to IBM Global Services as Big Blue’s only “crown jewel” ever since our recommendation for an IBM break-up back in 1996 (see "Break Up IBM!", Mar 20, 1996).  The IGS business results can help explain why.

Despite the slowdown in the 2001-2002 period, IGS net earnings have grown at a rate of 28% per year during the last eight years.  IBM’s, by comparison (which include IGS!), grew at only 3% during the same time.  Which goes to show us just how much of a drag on IBM earnings its other hardware businesses have been.

Text Box:

During the last five years, IGS’ net has grown at 16% per year as IBM’s net declined by 10% compounded annually.  In 2002, while IBM’s earnings dropped 54%, IGS’ declined 9%, mostly due to its new acquisition strategy.

In short, as IBM’s profit dropped, IGS’ importance rose.  And it jumped nearly six-fold in the last eight years.  IGS’ contribution to IBM’s bottom line increased from 10% in 1994, to 59% last year.  As a result, IGS, even without maintenance, has accounted for about a quarter of IBM’s profits during the last eight years ($12 billion of $52 billion - see the chart). 

This makes IGS an even bigger “crown jewel” today than it was seven years ago, when we first coined this phrase.

IGS’ contribution to IBM’s revenue has been even greater.  It accounted for 30% of IBM revenues in the last eight years ($198 billion of $664 billion).  And while its growth has slowed considerable in the last three years, this IBM unit still continued to outperform IBM’s overall growth (of which it is a part!) by more than five-fold (16% vs. 3% per year).  

Text Box:

In the last five years, IGS has grown at 10% per year, while IBM grew at 2% annually.  As a result, IGS’ share of IBM revenues went from 15% in 1994, to 39% last year. 

Maintenance “Cash Cow”

IBM, by the way, does not break out the IGS income statement and balance sheet results (only revenues and pretax profits are reported, bundled with hardware maintenance).  So the figures that you are seeing here are our estimates.  Revenues and pretax profits, of course, do match up with published IBM data.

One reason we have been excluding hardware maintenance from the IGS business analysis is that this activity has more to do with hardware than value-adding IT services.  In fact, until just three years ago, IBM reported maintenance as a separate item in its financial statements.  It was only when the former CEO Lou Gerstner became desperate enough for a boost to its only “crown jewel’s” profitability, that maintenance was merged with Systems Integration part of IGS.

Another reason we have been omitting maintenance from our annual analysis of IGS and the global IT services business is that none of the Top 5 vendors does it (Accenture, CGE&Y, CSC, EDS…).  They are all “color blind” when it comes to technology selection and repairs.  So it would not be fair to compare the results from business activities in which they do not participate.

Nonetheless, we do show the IBM maintenance revenues and profits as separate lines, both in our IGS charts and tables.  And it is from those figures that we were able to deduce IBM’s possible motive for including a hardware-related activity in IGS business.  Which is… that maintenance is still an IBM “cash cow.” 

Text Box:

While it took IGS $198 billion in revenues to generate about $12 billion in net profits in the last eight years, maintenance has achieved a $10 billion net profit on revenues of only $52 billion during the same time frame (see the chart).

In other words, maintenance is much more profitable than the rest of the IGS operations.  And with its annual revenues stabilized around $5 billion in the last several years, this IBM business segment continues to boost the apparent profitability of IGS as well as the actual profitability of IBM.

Segment Analysis

Of the five horizontal IGS business segments, Outsourcing continues to outperform all others.  With revenues of $15 billion in 2002, this operation represents nearly half of the IGS total.  

Text Box:

The newly formed Business Consulting Services (BCS) unit, which incorporates the former PwCC business, has leapfrogged over the Integrated Technology operation ($6.6 billion or 21% of total) into the second largest IGS segment ($9.3 billion or 30% of total). 

The remainder (about 1%) of IGS revenues is attributable to its Learning Services unit.

Summary and Outlook

The 26% revenue surge in the first quarter of this year should provide a pretty good indication of what’s in store for IGS in 2003.  The bulk of the percentage increase was due to the PwCC acquisition, of course.  Which means that such beneficial quarterly comparisons will wane after the end of this year.

Text Box:

Meanwhile, since downward economic pressures on consulting services continue to be felt across the global economies, we expect the BIS part of IGS to shrink about 5% in 2003 (to $8.9 billion) adjusted for full year’s pro-forma business results.  But this will be more than offset by a robust (double digit, 12%) growth in its biggest unit. 

Coming on the heels of strong new contract sales, we expect the Outsourcing revenues to reach about $16.8 billion this year.

We expect the Integrated Technology unit also to grow in 2003, albeit much more modestly (up 3% to $6.8 billion).

IGS overall 2003 revenues should rise by about 4% to $32.5 billion ($37.5 billion with maintenance).  If IGS succeeds in maintaining its gross margin around 24%, as it has been in the last several years, we expect its net profit to increase by 19% to $2.5 billion. 

Given the economic hardships that the rest of the major competitors continue to report from around the world, and continued troubles in IBM hardware businesses, an 8% IGS net margin should be music to IBM shareholders’ ears.

Happy bargain hunting!

Bob Djurdjevic


[1]  Excluding maintenance ($5.07 billion)

For additional Annex Research reports, check out...

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

2002 IGS: "Half or Double Trouble?" (Aug. 12, 2002), "IBM to Take $500M Charge" (Sep 3, 2002), IBM-PwCC Update (Oct 2, 2002), Analysis of IBM Second Quarter Results (July 17, 2002), IBM Layoffs Confirmed! (Aug 14, 2002), Analysis of IBM Third Quarter Results (Oct 16, 2002), Boom Amid Gloom and Doom (Oct 10, 2002)

2002 IBM: “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.]

Or just click on and use appropriate  keywords.






 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Volume XIX, No. 2003-08
April 30, 2003

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

P.O. Box 97100, Phoenix, Arizona 85060-7100
TEL/FAX: (602) 824-8111

|Annex Research | Annex Bulletins | Quotes | Workshop | Feedback | Clips | Activism | Columns