Annex Bulletin 2005-14                      May 13, 2005

Excerpts from Confidential Client Edition

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IBM CORPORATE

Update to Annex Research’ Five-year IBM Forecast

Tweaking Big Blue

IBM Touts Its “Small Is Beautiful” Strategy (SMB, Emerging Markets), New Growth Businesses, But Message Falls on Deaf Ears on Wall Street

PHOENIX, May 23 – It was supposed to be Big Blue’s usual semi-annual dog-and-pony show for Wall Street analysts.  But the Friday (May 20) half-day session turned out to be much more than that.  After a disappointing first quarter (see “Slammed and Dunked,” Apr 2005), it was a chance for top IBM executives to demonstrate to investors that they’ve got a handle on the problems and a sound strategy to overcome them.

They did it by stressing the importance of the small and medium business (SMB) market, of  emerging (large) countries, of BPO (business process outsourcing), and of solutions and globalization in general. 

[snip]

The messages fell on deaf ears.  Despite such bullish comments, the IBM stock dropped about 1% at the start of trading; cut its loss in half mid-way through executive presentations; and then dropped again at the end of trading, even as the Dow Jones industrials average, of which IBM is a part, rose later in the day (May 20 – see the chart).

SMB Market.  One reason for Wall Street’s phlegmatic skepticism may be that there really wasn’t much new in IBM strategy or tactics.  The company has been talking about the SMB importance for over two years now (see “Finally Heard,” Jan 2003, “Finally Heard – Part II,” Nov 2003; “SMB Express,” [clients click here] Feb 2005, and our iSeries Whitepaper).  Can the leopard change its spots?  For, the results have not backed up IBM’s rhetoric. 

[snip]

BPO Market.  Another arrow in IGS’ (and, therefore, IBM’s) quiver is the business process outsourcing (BPO) market, which IBM calls Business Performance Transformation Services (BPTS). 

Like the SMB market, the BPO idea is nothing new.  Accenture, for example, has been pitching the concept since at least 1996 under the name “transformational outsourcing.”  Perot Systems called it “functional outsourcing” in about the same time frame (see the “Holy Grail” story, slide - Jan 2004).  As other vendors hopped on the BPO bandwagon, they tried to market it under new different names as if it were an original idea.

[snip]

Services Acquisitions.  Finally, IBM seems to have also heard us on the need for acquisitions in the services market:

“Looks like Big Blue is partially implementing our recommended “Save, Spend & Split”- growth strategy.  We first annunciated it two years ago, and reiterated it last April (see “Save, Spend and Split,” May 2003, and “Ditto, Ditto! Is Anybody Listening?”, Apr 2004).

IBM is spending some money on some (small) acquisitions in the services arena, and it has split off a major chuck of its unprofitable hardware portfolio (see “Good Riddance, Finally?,” Dec 2004).” 

(see “Quality over Quantity,” Mar 2005)

On Feb 2, for example, IBM beefed up its financial services unit’s “Lego collection” with an agreement to buy Equitant, a company that caters to clients looking to outsource their financial administration.  

[snip]

Software.  Like IGS’ Joyce, the head of IBM software, Steve Mills, also talked about downsizing of transactions.  “Our typical transaction size is now (only) $50,000,” he said. 

So IBM software unit faces similar challenges as does IGS – doing more for less.  But having been at it longer, and having been hardened in tough battles against vigorous competitors, IBM software already has an impressive track record of growth through acquisitions and partnerships.

[snip]

Hardware.  Bill Zeitler’s presentation on the company’s hardware strategy was probably the most upbeat and the most candid of all IBM executive comments. 

“After several years of outgrowing the market and gaining share, we turned in a very disappointing performance in the first quarter,” he said, not trying to mince words or come up with excuses. 

[snip]

Zeitler then stepped through his individual product lines’ strategies and remedies that have been put in place.  On the mainframe side, he noted that its security, integration qualities, along with new workloads (Linux, Java), would ensure that the zSeries resumes its upward march (just as we also noted in our zWhitepaper: “Poughkeepsie Spring”).

[snip]

Emerging Markets.  IBM’s discovery that the world’s major emerging markets (Russia, India, Brazil, China) may be the key to its future long-term growth, is perhaps the only relatively new strategy that Big Blue unveiled both on May 20, and on April 14, when it released its first quarter results.

[snip]

Solutions.  Elix and other IBM executives also talked about “solutions opportunity” as if it were a novel idea:

“Solutions are growing faster than the rest of the market. While point products will remain an important part of our business, we need to focus on high-value solutions to meet clients’ needs and drive our growth” – reads the sub-heading from a Doug Elix chart (see above).

Actually, IBM’s former CEO, John Akers, also sought refuge in solutions rather than products when he first ran into trouble 17 years ago:

[snip]

Summary & Outlook

IBM has already shifted its model from commodity-like businesses to higher-value-higher-margin operations through divestitures and a change of strategic emphasis, especially in the last three years, said IBM’s Loughridge, the CFO (see the above chart and “Quality over Quantity,” Mar 2005).

This trend will continue in the next four-to-five years, though the rate of the margin improvement will diminish over time (also see the forecast charts).

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