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


Analysis of IBM Second Quarter Business Results

Ban IBM Hoarse Whisperers!

Managing Wall Street Analyst Perceptions Is an Area of IBM Excellence

PHOENIX, July17 - Managing Wall Street analysts’ opinion is one area in which IBM seems to excel.  Always has.  Especially when it is expected to unload a truckload of bad news on the market.

The second quarter is a case in point.  It was downright ugly, if you consider the facts.  IBM barely managed to break even ($56 million net) on revenues of $19.7 billion, down 6% from a year ago.  That’s when IBM made over $2 billion at the bottom line on revenues of $20.8 billion.

So look for the IBM stock to rise tomorrow.  No kidding.  In fact, the Big Blue shares have already risen in after-hours trading.  That’s how perverse Wall Street has become these days.

Take a look at these two Reuters’ headlines.  If your mind uses logic instead of whim for reasoning, start scratching your head…

Wednesday July 17, 4:58 pm Eastern Time

Reuters Market News

IBM Posts Sharp Drop in Profits

Wednesday July 17, 5:04 pm Eastern Time

Reuters Business Report

IBM Jumps in After-Hours Trading

NEW YORK (Reuters) - Shares of International Business Machines jumped in extended trading after the technology bellwether posted earnings that beat Wall Street forecasts even though they dropped for the fourth consecutive quarter. […]

How’s that possible?  The secret’s in whispering.  The IBM Deep Throat seems to have been whispering its expected numbers so loudly to analysts that it got hoarse doing it.  Move over Robert Redford (the star of the “Horse Whisperer” film).  Here come the Big Blue “Hoarse Whisperers.” J

Guess that’s what it takes to get Wall Street analysts to perform their “independent” analysis.  You have to shout the figures into their ears.  Until they form the infamous “consensus” that everybody expects.  When the company exceeds its own figures even by one cent (as in IBM’s case 84 vs. 83 cents per share), suddenly a loser becomes a hero.  And a disappointing quarter leads to a stock rise.

The art of good investor relations?  That’s one way of looking at it.  Incestuous self-dealing is another.  Especially when you throw in the $1.8 billion IBM spent in the second quarter lining Wall Street’s pockets with stock buybacks ($47.6 billion since 1995 - see the chart).

Text Box:

Never mind that this and the $2.1 billion pretax write-offs contributed to a $2.8 billion negative cashflow in the first half of the year.  Graduates of There-Is-a-Sucker-Born-Every-Day School of Thought don’t concern themselves with such details. 

But maybe Congress should?  After they are finished putting handcuffs on some distinguished honorees of the Shyster CEO University, they should examine the incestuous relationship between Wall Street research and the companies it researches. 

For, while IBM and Wall Street may be laughing all the way to the bank on this temporary stock boost, members of the investing public, who are not privy to the whispering that goes on between public companies’ Deep Throats and Wall Street “research,” may end up holding the bag when the stock eventually drops.  As it invariably will, given Big Blue’s dismal business results.

Business Segment Analysis

Geographies. All IBM geographic segment revenues were down in the second quarter.  Americas region declined by 5% (4% in constant currency), Europe dropped 3% (7% in constant currency), while Asia/Pacific contracted by 3% (2% in constant currency).

But the OEM business shrank the most precipitously - down 32% (31% in constant currency).

Services. IBM Global Services, Big Blue’s erstwhile “crown jewel,” also reported its second successive declining quarter.  In fact, as the hardware maintenance portion of its business showed a modest increase (up 1%), the rest of the services experienced a 2% drop. 

The decline was led by the Business Innovation segment, which was down 11%.  This activity accounts for about a quarter of the total IGS revenue and includes the struggling consulting business.  The Outsourcing and Integrated Technology services went up by 2% each.

But perhaps the most disturbing part of the IGS second quarter report card was its heretofore bustling new contract performance.  It was “only” $10.6 billion, far below the first quarter’s $15 billion total, and the $16 billion IBM sold a year ago.

Since about 15% of new contracts signed in a given quarter contribute to revenues (a surprisingly high number, we think!), according to the IBM CFO, John Joyce, this drop-off put a crimp on IGS’s growth.

The IBM CFO once again complained about several megadeals “falling out of the quarter.”  No $1 billion or bigger deals actually materialized.  IBM was banking on them to close in the second quarter.  This was the third time in a row we’ve heard Joyce use the same excuse. 

You’d think that the big ones that got away in December would have been hooked by now, wouldn’t you?  Except if the angler is clumsy and the big fish are merely a figment of his imagination?

So when Joyce rejoiced in the revelation that the “pipeline” was the best IGS has ever had, we could not help but wonder if the IBM CFO may not have been confusing the “pipeline” with “pipedream?”  Especially when you consider that IGS’s backlog declined in the second quarter for the first time ever! (see the chart).

Text Box:

That was evidently due to, what IBM now calls, “rescoping” - a “new English” word.  It has been coined to depict the old-fashioned customer reneging, or contract renegotiations, coupled with the usual cancellations and expirations.

As a result, not only have the services revenues declined, but the IGS  pretax profit has also dropped by 46%!  This makes the software now IBM’s most profitable segment ($913 million vs. $706 million for IGS), despite its relatively small revenues ($3.3 billion vs. $8.7 billion for IGS).

Text Box:

Hardware. IBM hardware businesses continue to drop like a led balloon.  Overall hardware revenues were down 16%, led by the pSeries (Unix) decline of 27%.  IBM blamed it on an “intense competitive environment.”  Meaning that Sun is eclipsing the Big Blue moon and eating its lunch? 

The iSeries (AS/400) revenues also declined steeply (26%), while the mainframe business (zSeries) shrank by 19%.

The only uptick among the IBM servers were the xSeries (PC) systems whose revenues were up 13%.

The disk and tape storage revenues dropped by 25% and 13% respectively.

Making things worse for IBM, Technology, PC and Enterprise Investment units - all lost money in the quarter.  Technology led the way with a huge loss of nearly $1 billion ($943 million - related to the Hitachi deal and other asset write-offs).

As we’ve already noted, software was the only IBM segment that grew in the second quarter.  Even better news for IBM shareholders is that the software pretax margins also improved - from 82% to 85%.


Looking ahead, IBM warned Wall Street not to expect the rapid growth rates that the IBM CFO predicted the IGS unit would generate in the second half of the year.  Joyce kept stressing that the key to revenue growth is new contract sales.  And until such time that IBM services sales people start to close more and bigger megadeals, chances for faster revenue growth are rather slim.

Happy bargain hunting!

Bob Djurdjevic














































Volume XVIII, No. 2002-17
July 17, 2002

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