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IBM CORPORATE

Annex Research Five-year Forecast for IBM

Ditto, Ditto! Anybody Listening?

“Save, Spend and Split”-Strategy Still Valid Today, But Is Anybody Listening at Armonk?

PHOENIX, April 8 – Nearly one year ago, our growth strategy recommendation to IBM was Save, Spend and Split:”

The only way Big Blue may get nimbler and substantially bigger beyond 2004 is through savvy acquisitions, preferably in the services sector. 

(see “Save, Spend and Split,” May 2003).

Ditto one.  The same thing is true today.

Which was also true two years ago.  Here’s what we suggested to Sam Palmisano in 2002, shortly after he had taken over as the IBM CEO:

As to… catching the next wave, the best way to do it is not for Big Blue to sit around and pray, hoping the inspiration would magically come out of the blue.  Rather, IBM should go out and seek it proactively - meaning IBM should go fishing.  Instead of wasting money on stock buybacks, IBM should start buying up a whole lot of promising upstarts, hoping to find a pearl among the oysters.

(see “From Here to Eternity”, Apr 2002)

Ditto, ditto.

So has Palmisano heeded and embraced our recommendations?  Sort of… but not very heartily.  And not all of them.

Big Blue did buy PriceWaterhouseCoopers Consulting (PwCC) in July 2002.  And it did integrate it last year into its IBM Global Services unit nearly flawlessly and seamlessly. 

But that’s about it.  The rest of its acquisitions were first, scarce; second, the garden-variety types in software or technology fields.  None will be significant in terms of adding to IBM’s long-term growth - the main objective of our “spend” recommendation. 

Plus, IBM has now resumed squandering its shareholders’ money on stock buybacks (see "Hype Exceeds Results," Jan 2004). So forget the “Save”-part of our advice, too.

As for the “Split”-part, well, one has to grow first before splitting.  And while 2003 was certainly a much better year than 2002, IBM hasn’t been exactly setting any growth records, especially if the PwCC acquisition were prorated over the year before, and the IBM results adjusted for currency gains.

On the plus side, IBM did get rid of at least one money-losing operation in 2002.  It sold a part of its storage business to Hitachi while taking a hit on earnings that year.  Getting rid of its losers is the kind of a move that we also said was necessary if IBM is to grow again.

And that’s about it, again.  The PCs continue to lose money in most quarters, while sapping management and other resources.  Ditto – re. IBM’s remaining Technology operations.

Indian Acquisition

That IBM seems unsure about how to go about making strategic acquisitions became painfully obvious today.  The company announced on April 7 that it would buy Daksh, India's third-largest back-office services firm.  Estimated at $150 million to $200 million and expected to close in May, it is the biggest takeover so far in India’s booming $3.5 billion IT sector.

The deal will give Big Blue access to the privately held Daksh's 6,000-strong work employees.  Daksh offers call-center services to 13 clients, including Amazon.com.

And how is this Indian acquisition going to help IBM’s growth?  It won’t.  It will probably help lower its service delivery costs – which is the main reason for the various IT multinationals setting out on a “Passage to India.”  So much for (not) heeding the “Spend”-part of our recommendation.

Forecast

So if IBM is not saving its money anymore (from stock buybacks); if it isn’t spending it wisely (on strategic acquisitions), and if any talk of splitting is premature without prior growth – what’s the five-year outlook for Big Blue?

In a word, it’s blue.  Unless IBM gets really aggressive with its acquisitions, especially in the services arena, it will be singing the blues after 2005.  We expect IBM revenues to peak at $92.3 billion in 2005, and then decline at a compound annual rate of 2% through 2008 (see the chart).

Hardware will decline at 9% per year between 2004 and 2008, software at 3% per year, while services will grow at 3% annually during the same period (4% without maintenance).

Global Financing and Enterprise Investments will also shrink at 12% and 7% respectively during the next five years.

As a result, unless IBM changes its current tack, we see a smaller Big Blue in 2008 than it is today (about $81 billion in revenues, roughly the size it was in 1998).

Naturally, IBM earnings will also erode after 2005 - at an estimated rate of 7% per year.

The reason is very simple.  IBM is in too many declining businesses.  And it is doing little to get rid of them, or to acquire new, faster-growing ones. 

Until it does, we don’t see any reason for the IBM stock to rise, contrary to the ever-bullish Wall Street forecasts for Big Blue.

Happy bargain hunting

Bob Djurdjevic

2004: IBM: Five-year Forecast (Apr 8); Mainframe at 40! (Apr 2);  Accenture: Burning the Track (Mar 2004); "Crown Jewel" Restored? (Mar 2004); "Cap Gemini: Another, Smaller Loss" (Feb 2004);  "CSC: Good Quarter Gets Boos" (Feb 2004); "Hot Air Jordan" Flaunts Flop as Feat (Feb 2004); "Hype Exceeds Results" (Jan 2004);  "Cronyism Is Alive and Well at EDS" (Jan 2004);  "Five Most and Least Likely Forecasts for 2004" (Jan 2004)