Annex Bulletin 2006-14                               April 14, 2006

Excerpts from CONFIDENTIAL client edition

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IT SERVICES

Updated 4/14/06, 5:00PM PDT; updates Outlook

Analysis of IBM Global Services' 2005 Business Results

Jewel Develops Patina

Profit Drops Sharply on Small Revenue Increase 

SCOTTSDALE, Apr 14 - Big Blue's brightest crown jewel of the 1990s has developed a patina in the 2000s.  The 2002 PwCC acquisition temporarily masked the IBM Global Services (IGS) weaknesses by boosting its revenue growth into double digits.  But in 2005, the world's largest IT services firm returned to its old slow or no growth ways.  

For the full year, IGS revenues rose 2.5% to $47.4 billion, or 52% of IBM's total.  But pretax profits dropped 16% to $3.4 billion, for a 7% pretax margin.  We estimate that last year's net earnings plunged even more steeply thanks to higher tax rates - down 22% to $2.2 billion, for a 4.7% net margin.

[snip]

Sales Slowdown, "Rescoping" and Backlog Issues

Meanwhile, back to IGS, as we've said many times since the start of this decade, IBM's services unit will have a hard time sustaining its growth without some major acquisitions.  That's in part because IGS is losing business from the bottom end of its backlog.  Here's what we said about its latest quarterly results (4Q05):

[snip]

Declining Profitability

So new contract sales shortfall and backlog shrinkage are two additional negative long-term factors that are slowing down IGS's growth.  But they do not directly affect another troubling development, peculiar only to 2005 so far.  Which is IGS' declining profitability.  Nothing new there...

[snip]

Business Outlook

So what does the future hold for IGS?  Well, we figure that 2006 will  represent a modest improvement over 2005. 

[snip]

Any additional growth spurts are unlikely without major acquisitions.  And we cannot think of any that would truly enhance the quality of the IGS business and not just the quantity.  So if Palmisano's emphasis on quality remains at the top of his strategic agenda, smaller will be probably better in IGS' case, too.  

But this may be a hard concept to sell on Wall Street.  The fact that the IBM stock is still lower today than it was a year ago, despite a significantly better quality of its business mix, is proof of it.  Still, if IGS 2006 profitability were to improve as outline above, it would bolster Palmisano's case and IBM's stature on the Street.

[snip]

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Volume XXII, Annex Newsflash 2006-14
April 14, 2006

Bob Djurdjevic, Editor
(c) Copyright 2006 by Annex Research, Inc. All rights reserved.
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