Annex Bulletin 2007-14                              April 16, 2007

A partially OPEN client edition

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IBM FINANCIAL

Updated 4/16/07, 4:30PM PDT

A Preview of IBM First Quarter Business Results

IBM Stock Still Grossly Undervalued

Priced at Peer P/E Ratios, IBM Should Be Worth $124?

SCOTTSDALE, Apr 16 - IBM stock is inching up toward its closing price of 2006 ($97), but it is still down for the year and is grossly undervalued relative to its peers.  

Our latest analysis, done on the eve of Big Blue's first quarter results, basically confirmed what we said nearly five months ago.  IBM stock should be worth $124 if priced at peer P/E ratios.  We said as much in late November when we also took the market temperatures of IBM and its five peer competitors (see "A $125 Stock," Nov 2006, and "Grossly Undervalued," July 2006).

And how did we arrive at such conclusion?  By analyzing the business fundamentals and market data of IBM, HP, Fujitsu, EDS and Capgemini - three conglomerates and two global services competitors.

As you can see from the above chart, the IBM net profit is about three times higher than the average of these five competitors, yet its price/earnings (P/E) ratio is 31% lower.  Putting it another way, if the IBM peers' average P/E ratio were applied to Big Blue's business fundamentals, its stock price should be $124 per share.  Instead, IBM closed today at $96.18, up 1.3% on the day (Apr 16).

The same pattern is discernible from a comparison of IBM vs. five major competitors' profit margins.  IBM net and operating profit margins are about three times those of its peers (see above chart).

Outlook

Based on everything we have seen and heard in the marketplace during the first quarter, this pattern will continue after tomorrow's results are release, if not widen in IBM's favor.  IBM is likely to hit or exceed analyst expectations (revenues of $21.86 billion, EPS of $1.21, according to Thomson Financial).  

It remains to be see if the company gets the credit for it on Wall Street this time around that has eluded it in the past.  During the last year or so, investors seem to be more preoccupied chasing the values elsewhere in the IT industry, such as Apple or HP, for example.

Meanwhile, while looking up wistfully up at the HP and Apple stock gains in thIBM_MSFT.JPG (46951 bytes)e last 12 months, IBM shareholders can console themselves by looking down at Microsoft.  For once!  Wall Street has treated the erstwhile IT industry highflier in the last year with even more disdain than the Big Blue stock.  That was the first time something like that has happened since Microsoft's rise to prominence in the IT industry (see the thumbnail chart).

Meanwhile, IBM's one-string instrument for propping up the stock price isn't working14_IBM5.jpg (45659 bytes) anymore.  Even though the company has spent $76 billion since 1995 trying to entice Wall Street into favorable valuations, most of it in the last 7 years (see the thumbnail chart), Big Blue's market cap keeps sliding even faster than the drop in shareholders equity.  

Maybe if the company stopped minding Wall Street opinions, and started minding its business (by investing all these billions into acquisitions instead of lining investment bankers' pockets), favorable valuations would also soon follow?

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

Happy bargain hunting!

Bob Djurdjevic

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Volume XXIII, Annex Bulletin 2007-14
April 16, 2007

Bob Djurdjevic, Editor
(c) Copyright 2007 by Annex Research, Inc. All rights reserved.
e-mail: annex@djurdjevic.com

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