Annex Bulletin 2011-02                            January 11, 2011

A partially OPEN edition

Recent...

IBM Hardware to Rise and Shine Again (Analysis of IBM STG business results and outlook)

BARRON's: IBM Shareholders Will Like New Year (Analysis of Barron's article on IBM stock)

INDUSTRY TRENDS

 

Updated 1/11/11, 11:11AM HST

Analysis of Top Global IT Companies' 2010 Stock & Business Performances

Consumer Rules

Consumer-, Internet-driven Companies Leapfrog over Enterprise Providers, Mass Markets Attract More Wealth Than Corporate Specialists

IBM, Wintel Undervalued? EMC, Apple, Google, Oracle Overpriced?

HAIKU, Maui, Jan 11 It is that time of the year again, the time to take stock of the stocks.  This time around, however, we are doing it at an especially auspicious time.  This report is being released on the year, month, day, hour and minute of the Aces (1/11/11 at 11:11).  Just don't try to take it to Vegas.  We hear they prefer the 7's over there. :-)

Wish we could tell you that No. 7 was also the magic number in our year-end analysis of the top global IT companies' stock and business performances.   About the only thing that the No. 7 stood out for was the seven losers in the market cap game in 2010.  Eight of the top 15 IT companies saw their wealth increase last year.   The remaining seven saw it shrink, despite strong business results for most of these vendors (right chart).

Apple, EMC, Accenture and Oracle stood out as the most sought out stocks.  The largest computer company, HP, was dead last, with Cisco and Microsoft hovering just above it in the cellar.  Obviously, investors are moving their money toward, what they perceive as, the future winners.

2010: Modest Gains on Average

As a group, the top 15 experienced a modest (5.4%) appreciation in their market values last year.  We said in our first report of 2011 that IBM has once again become the bellwether stock of the industry (see IBM Hardware to Rise and Shine Again, Jan 3).  This analysis confirms it.  IBM's market cap appreciated by 5.8% in 2010 (i.e., right about the average for the top 15 global IT leaders).

While market cap increase was modest, the business results of the top 15 surged.  Revenues rose 15% on average, while earnings jumped 49%.  Take away a couple of anomalies (huge percentage increases of two companies whose earnings the year before were very low), and you will end up with a more realistic 39% average earnings increase in 2010.  Still very strong.

So why did the market cap rise only 5% if the revenues and earnings surged in double digits?  Because Wall Street had anticipated them to back in 2009.  We said in the fourth quarter of 2009 that the stock market rally then taking place was a bet that future earnings would be much higher (see A Rally of Hope over Fact, Oct 2009).  And now that that has happened, investors are looking ahead again, but not seeing an encore in stellar business performances.  Which is why they are placing some of their bets elsewhere.

Consumer Rules: Mass Markets' Attract More Wealth Than Enterprises

But averages can be dangerous.  Just think of that well-known statistician who drowned while trying to cross a lake with an average depth of three feet. :-)  If we look at the components that make up the average, we will find that consumer-driven and software companies are outperforming by a wide margin the enterprise-serving giants.

Take a look at this table...

Industry Segment Mkt Cap P/E   % of Tot Rev chng Earn chng
    31-Dec-10          
Software (4) $469.71 18.30   29% 18% 26%
Services (1) $33.85 17.21   2% 8% 28%
Hardware (4) $302.75 17.57   19% 24% 45%
Consumer (3) $507.36 23.01   32% 52% 138%
Conglomerate (3) $288.30 14.41   18% 2% -10%
               
Total Top 15 $1,601.97 18.20   100% 15.3% 39.3%
               
10-Jan-11    Source: Annex Research          

The seven predominantly consumer-driven and software companies accounted for nearly a trillion dollars or 61% of the $1.6 trillion total market cap.  Companies operating in mass markets are attracting more wealth than those active in the traditional enterprise industry segment.  Large conglomerates (HP, IBM, Fujitsu), the original computer companies, represented but only 18% of the total.  Clearly, a change of the leaders, is taking place in the IT industry.

No surprise there.  This shakeout merely confirms and underscores something we predicted  almost 15 years ago - that smaller will be better awpe2.jpg (31149 bytes)nd bigger over the long haul (see Louis XIX of Armonk, Aug 1996).

The chart on the left, which we lifted from that Annex Bulletin, tells the tale.  As you can see, back in 1995, we thought that by 2010, consumer markets would experience the fastest growth (19% CAG), followed by small and medium size business market (SMB - up 11%/yr).  Meanwhile, the large companies would be largely a stagnant market we said even in the chart title - rising only about 1% annually. 

So the IT companies that refused to change and which stayed wedded to the familiar (enterprise) market had limited their own growth opportunities.  And the companies that were willing to change an innovate, such as Apple (and later Google... which did not even exist in 1995!), ended up prospering beyond their wildest dreams.

Not a Fluke

Nor is this shakeout some sort of a Wall Street fluke, another of its quirky ways of looking at the world, as investors are sometimes known and prone to do.  This shakeout is for real.  It is not Wall Street-driven.  The three consumer-focused companies reported a revenue increase of 52% in 2010, and a whopping 138% surge in net profit. 

Apple's earnings alone skyrocketed 194% on a 128% jump in revenues, while Google's soared 81%. As a result, Apple is now bigger than Microsoft, both in revenues as well as market cap (left).  A major change at the top.  An industry upstart from the 1980s is now a veteran laggard.   Apple has also virtually caught up with IBM in terms of earnings (right).  Another IT industry milestone.

Ironically, Apple is industry upstart from the 1970s.  And it is again a highflyer of the 2010s.  Maybe Apple should change its name to Phoenix? :-) [rising from the ashes].

Which goes to show us that the current laggards should not despair.  Even some old-time highflyers from the 1950s and 1960s, like IBM, have a chance of regaining the leadership.  All it takes is the courage to change and innovate.  And believe in oneself.  Steve Jobs of Apple a.k.a. Phoenix wrote a book on how that can be done over and over again.

By the way, Apple now also tops all in terms of equity (right).  Intel, Microsoft, Cisco and Google follow.  IBM, the industry's oldest company which is celebrating its 100th birthday this year, is only eighth.  Ah, the buybacks can have a big bite...

IBM Still Undervalued?  Intel, Too?

Meanwhile, Big Blue shares have also staged a modest rally since we said last year that they ought be worth about $176 relative to its top 8 peers on the IT industry leader board (see BARRON's: IBM Shareholders Will Like New Year , Dec 24 and Analysis of Top IT Cos' stock market & business performances, Oct 11).)  But we also warned not to expect that level any time soon.  Because the IT industry rally seemed to be running out of steam, we said.  And highflyers rarely fly solo.

Three months later, we see that IBM shares did rise a little (5.4% to $147 as we write this), a little less than the 6% Dow Jones industrials' increase.  But they are still far off the level the stock should be trading at if the average P/E ratio of its peers were applied to Big Blue (left chart).

As you can see, EMC, Google, Oracle, Apple, SAP, Yahoo dominate the top of the P/E ratio chart.  Which means they are the companies Wall Street thinks, right or wrong, that have the best earnings potential in the future.   By contrast, Intel is at the bottom of the pile, with Microsoft, HP and IBM hovering slightly above it.

Now if we take the top 8 IT leaders and consider their P/E ratios and market valuations, this is the table that sums it up...

If IBM and Intel were priced in line with their peers' shares, their stock prices should be about $183 and $31 per share respectively.  Instead, they are trading at $147 and $21 respectively.

That's about a 25% discount for the Big Blue share relative to its peers at the top of the industry pyramid.  And Intel's are even more of a bargain - available at 48% off the "list price" (meaning at the average P/E ratio of the top 8 leaders).

Which reminded us of something a senior IBM executive said at an industry analyst conference in New York last November.  Steve Mills, who now heads up all IBM software and hardware units, said that "only IBM and Intel that are capable of manufacturing the highly integrated circuits, such as the 5.4 gHz chips."  Mills made that point by way of explaining why he expected Oracle to move away from SPARC and toward Intel.

So the only two companies in the industry that have the capability to produce greatest technological breakthroughs are the bargain basement discount leaders among the top IT vendors' share prices.  Now THAT'S a quirky way of looking at the world which Wall Street sometimes exhibits.  Which, of course, makes IBM and Intel good buying opportunities before the traders correct their quirkiness it out.

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

Happy bargain hunting

Bob Djurdjevic

P.S. Looking at the clock right now... It is 11:11 on 1/11/11.  Time to release this report.

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Volume XXVI, Annex Bulletin 2011-02
January 11, 2011

Bob Djurdjevic, Editor
e-mail: annex@djurdjevic.com

(c) Copyright 2011 by Annex Research, Inc. All rights reserved.
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