Excerpts from analysis of IBM 2Q06 results (July 18, 2006)

Annex Bulletin 2006-28 July 18, 2006

Excerpts from CONFIDENTIAL client edition

IBM FINANCIAL

Updated 7/19/06, 12:10PM PDT, adds Market Reaction...

Analysis of IBM's Second Quarter Results

No Bad News Is Good News

Market Breathes Sigh of Relief after IBM Release

SCOTTSDALE, July 18 - Market breathed a sigh of relief after IBM's second quarter financial release, lifting the stock more than two points in today's after-hours trading. Absence of major bad news was welcomed good news by the battle-weary investors, buffeted by a myriad of scary global and economic developments in the last week or so.

[CHARTS HERE]

The Big Blue shares had set a new 52-week low earlier in the day of $72.73. They are still down 11% since a year ago, and more than 25% bellow the January 2005 level. In fact, with so much pent-up pessimism in the marketplace, "the only way to go after the IBM release was - UP," we had told the major business media before Big Blue announced its earnings.

[snip]

Business Segment Analysis

Global Services. IBM's largest business segment was also the biggest disappointment in the quarter. IBM Global Services (IGS) revenues declined again by 1% to $11.9 billion. More worrisome, however, was a precipitous 34% drop in new contract signings to $9.6 billion, and the corresponding $2 billion sequential decline in the backlog. Since a year ago, however, the IGS backlog is down $4 billion. It is $9 billion lower than in the second quarter of 2004.

[snip]

And what are its problems? In a word, it is its size. The unit is simply too big for its own good. Nothing new there, of course, for Annex clients and readers. We have been saying since 1996 that Big Blue should consider splitting it up. Well, now that's even more evident than ever.

And how should IGS be broken up?

[snip]

Hardware. IBM second quarter hardware results were mixed. A seven percent jump in mainframe revenues was a positive surprise. So was a 45% surge in Microelectronics business. But revenue shortfalls caused by operational problems in System i and System x server product lines were unexpected disappointments.

[snip]

Software. IBM software continues to be the company's most profitable operation, contributing almost $1.2 billion to Big Blue's pretax profit. IBM also grew its second quarter software revenues by 5% to $4.2 billion. WebSphere and Tivoli had double-digit growth, while IBM's "key branded middleware" enjoyed a 9% jump since a year ago.

[snip]

Geographies. That was evidently no small feat as IBM's overall geographic results were pretty anemic. The America's region grew by 1% since a year ago, but Europe and Asia/Pacific were both down (4% and 9% respectively). It was the OEM sector that produced the best results, rising 34% in the period.

[snip]

Industries. Small and medium business (SMB) and financial services were the best IBM industry sectors in the second quarter. Their revenues rose 4% and 2% respectively. The rest of the sectors declined.

[snip]

Outlook

Loughridge acknowledged disappointment in services contract signings. But he was encouraged about the future demand.

"Clearly there's enough opportunity,'' he said of the services' sales outlook. "We just need to get it signed.''

[snip]

"That's all she wrote," we're afraid, for those of you who are NOT Annex Research clients, who are now reading the complete Annex Newsflash, along with all charts which back up our story.

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Happy bargain hunting!

Bob Djurdjevic

Market Reaction

SCOTTSDALE, July 19 - IBM's second quarter results helped lift the shares of some of its competitors more than its own stock. A weird market reaction? But true, nonetheless. Take a look at the chart as of mid-afternoon Eastern time...

We said last night that you should " stand by for additional stock price hikes tomorrow, as broader markets digest and act upon this news." And indeed, that's what happened this morning, when the IBM stocked moved up more than three points even before the Fed chief Ben Bernanke ignited the market with his comments at today's Senate hearing. But then, that's all she wrote. From then on, Big Blue shares have been on a slightly declining curve.

The reason? Wall Street research evidently cast a downcast spell over the upbeat Big Blue numbers, helping jade the investors' opinions, too (see the AP story, "IBM Up Despite Bearish Analysts," July 19). Analysts' negative comments halted the Big Blue advance and pushed up the shares of its competitors (like Dell, HP, Accenture, Perot Systems... etc.).

So what's IBM to do? Apply the full court marketing press on Wall Street investors, especially the buy-side of the Street and the hedge funds. Breaking up IGS to foster growth would get their and everybody's else attention (for details, check out our above comments about the IBM services results).

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Volume XXII, Annex Newsflash 2006-28
July 18, 2006

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