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Excerpts from the Confidential Client Edition
Analysis of IBM’s Fourth Quarter
Hype Exceeds Results
IBM Had a Good Quarter, But Not as Good as Wall Street Gave It Credit
PHOENIX, January 15
– The most remarkable thing about IBM’s just-released fourth quarter
business results was that they came early.
Five days early, to be exact, and also early in the morning (8AM
EST; IBM normally announces after the markets close at 4PM).
Was IBM trying to catch Wall Street napping?
If so, it appears the trick worked.
IBM shares went up 6% in early trading, before sleepy traders got
the sand out of their eyes, and realized that not everything is as rosy in
the Big Blue picture as IBM executives had painted.
So the IBM shares eased later in the day.
They still chalked up a 4% gain at the end of trading, closing at
The second most remarkable thing about IBM’s fourth quarter release was the amount of verbal hype IBM executives spewed out. We have not heard anything like that in years, not even in the best Gerstner days.
If Joyce is right, his outlook bodes well not
just for IBM, but also for its competitors.
None of them, however, sounded as bullish. Accenture, for example, got killed a couple of days ago
(stock went down 13%) following its release of very solid results in its
latest quarter. The
ostensible reason for the sharp drop in ACN shares was the supposedly
conservative and cautious remarks by Accenture executives about the future
outlook – the antithesis of the IBM hype today.
So what are we to conclude from these two
opposite examples? Perhaps
that Wall Street watches the executive body language more carefully than
the numbers. Analysts and
traders evidently pay more attention to hype than to results.
IBM numbers weren’t bad, but they weren’t as good as
Accenture’s. Yet the market rewarded IBM and punished Accenture.
And now, here are the highlights…
Business Segment Analysis
Geographies. IBM fourth quarter revenues went up 9% as reported, but increased only 1% in constant currency. In other words, IBM got a big boost from the weakness of the U.S. dollar.
Services. IBM Global Services (IGS), the unit that we once dubbed Big
Blue’s only “crown jewel,” reported an 8% growth in the fourth
quarter. Alas, the IGS
revenue growth translates into a 1% decline in constant currency.
Worse for the IBM shareholders, the
services’ profit margins are also shrinking.
The gross margins of IT services (without maintenance) dropped from
23.7% in 4Q03, to 22.1% in the latest period (they were 24.7% two years
ago). We estimate that the
corresponding pretax margins were only 8%, less than even hardware’s
(11%), and much less than software’s (34%).
Yet Wall Street analysts who cheered the IBM results, according to this morning’s wire reports, attributed their optimism to the supposedly strong IGS results in the fourth quarter. Were they sleep-talking?
Some also cheered the supposedly record IGS
new contract signings in the fourth quarter.
First of all, even though the $17.3 billion in new business sales
is an imposing and impressive figure, it is not a record. In fact, it is down 4%.
In the quarter a year ago, IGS sold $18.1 billion in new contracts.
More importantly, even though IBM said its
backlog rose to $120 billion, the company is still losing $11 per quarter
out of the backlog. Which
means that before any new deals are signed in any quarter, IGS is already
starting $11 billion in the hole (see the chart).
2003, for example, IGS sold $55.4 billion in new contracts, yet its
backlog went up by only $8 billion. Cancellations,
expirations and “rescoping” evidently amounted for the even more
foreboding difference ($47 billion).
And that’s the reason for optimism about the future growth? More likely, that may be the reason for the IBM hype. Is it supposed to distract us from following our noses and common sense?
Servers. The IBM servers, on the other hand, are a real success
story of the fourth quarter, and to a lesser extent, of the year. The
zSeries revenues were up 33% in the quarter (7% for the year), boosted by
shipments of the new mainframe models.
The server group finished 2003 with an 18% surge in the fourth quarter, and an 11% revenue increase for the year.
Software. The IBM software also had a very strong quarter, with
revenues growing by 12%, and the gross margin rising from 87% to 89%.
As a result, this IBM business segment topped all others in terms of pretax profit. Software accounted for $1.46 billion of IBM’s total pretax profit (a 29% margin) on revenues of $4.3 billion. IGS was second, slightly ahead of servers, with pretax profit of $1.1 billion (including maintenance) on revenues of $11.4 billion.
Industries. Last but not least, IBM’s industry report card for the fourth quarter showed a continuation of existing trends. The financial services sector continues to be the biggest IBM segment ($6.7 billion revenues in 4Q03), but it is now also the fastest growing industry unit (up 17% in 4Q03; up 13% for the year).
IBM’s fourth quarter results were right on
the money for the most part. Some
business segments exceeded our expectations (servers, software), while
others disappointed us (IBM Global Services).
But now that IBM executives have raised the bar for the rest of the
year and beyond with their bullish comments, they’ll have to deliver on
their promises, or else watch the stock suffer the wrath of disappointed
IBM may be about to find out that
“under-promising and over-delivering” is usually a better marketing
approach than “over-selling and under-delivering.”
But we are also ready to be surprised and corrected. Miracles do happen... So stand by for some interesting times ahead as we start to compare IBM’s optimism with the reality of quarterly results.
For additional Annex Research reports on IBM, check out...
2004: "Hype Exceeds Results" (Jan 15)
2003: "Small Is Now Big at Big Blue" (Oct 15); "A Passage to India" (July 22), “On the Nose But No Cigar” (July 16), “A Paler Shade of Blue” (June 2), “Save, Spend and Split” (May 8), “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.]