Annex Bulletin 2007-35                             October 12 , 2007

Recent...

Seedlings Sprouting Stronger Limbs - Update to "IBM State of the Union" [Annex clients click here]

An Apple a day keeps bear away (Analysis of Top 20 IT companies' market, business performances )

IBM CORPORATE

Updated 10/12/07, 4:00PM PDT

Update to Our 2007 "State of the IBM Union" Analysis

Seedlings Sprouting Stronger Limbs

Innovation Drives Growth; Server Brand Convergence Leads to New Sales & Marketing Model

Big "Green" Initiative Played Right into Our 2006 Garden Analogy

SCOTTSDALE, Oct 12 - Nearly one year ago, we first noted that "From Little Acorns Mighty Oaks Grow" (see right image).  The report was a part of our fall 2006 analysis of the "State of the IBM Union" and Big Blue's growth prospects.  And we concluded back then that, "as more Wall Street investors turn their eyes from feeds and speeds to weeds and seeds, more will recognize the growth potential of the new seedlings in the Big Blue garden.  As they do, the IBM stock will break out of its multi-year slump and surpass that two-year record."

Well, the IBM stock has certainly done that.  It closed yesterday (Oct 10) at $118.32, up 41% from a year ago, but still a little short of our $125-target price, that we also set last fall.  In the process, the Big Blue shares have also outperformed the Dow, of which they are a part, by more than double the rate of growth (see left chart).

Since that time, IBM's "green" initiative (see "The Greening of Big Blue", May 2007 and "The Greening of Big Blue, Part 2," Aug 2007) has played right into our garden analogy from last fall.  All we needed to do is change the color of the IBM logo from blue to green.  Here's an excerpt:

[snip]

So how are the "Big Green" seedlings doing a year later?  Are there any new ones that have sprouted since that time?  Here's our update to last year's fall "State of the Union" analysis...

IBM "State of the Union" Update

With IBM expected to report its third quarter results next week, we can only use the first half results as the latest indicators.  And they were good... very good, in fact.  Second quarter revenues were up 9% to $23.8 billion, with IBM's biggest and most profitable business segments growing in double digits.  Earnings per share grew even faster, rising 15% from a year ago.

Wall Street also liked it, pushing the IBM shares to about $115 (see "IBM Beats the Street," July 2007).  That was only three points below the current near-record level, but quite a bit above the August chasm caused by the turbulence in financial credit markets.  The crisis dragged down most IT stocks, including IBM's, but did not keep them down, as the subsequent rally lifted the Big Blue shares to nearly a six-year high ($120, set on Oct 2).

We had a chance to look more closely into the Big Green garden last week at an IBM Systems and Technology Group (STG) conference in Stamford, CT.  And what we saw was some last year's seedlings getting stronger and sprouting new limbs, and some new ones also jutting out of the mighty oak (right chart).

[snip]

New "Go-to-Market" Approach.  One of them was a new "go-to-market" approach, "a change from a brand-centric to a customer-centric format," according to Bill Zeitler (right), who heads up the STG, the $22 billion IBM unit that encompasses all of its hardware businesses.

"It's the most significant change in 15 years," echoed Bob Samson, the head of IBM's worldwide hardware sales whose job it was and is to implement the new marketing approach (left).

[snip]

Server Brand Convergence.  Furthermore, IBM can be expected to converge of its various server brands (x, i, p and z) into a unified "form factor" (box).  This process has already begun in the midmarket, with the merger of the high-end of the System i and p server lines announced in late July.  Over time, other brands will follow suit, including the high end of the the "p" and "z," though you should not expect that in the near future.

[snip]

Large Enterprises. At the high end, for example, where IBM has a 31% overall market share (41% in servers and 24% in storage), according to Zeitler, IBM's challenged it so keep the growth going through new initiatives, such as virtualization and IT optimization, and, of course, the "greening of IBM" and of the customer data centers.

[snip]

Custom Solutions.  In what IBM calls the "custom and embedded solutions" market, one of the new seedlings we analyzed last year, a relatively new opportunity for IBM, customers are spending about $92 billion per year on various engineering services, customized systems and chips, according to IBM (right chart).  But since most of the customers consider their own R&D as one of their "crown jewels," it has been tough for IBM to demonstrate why Big Blue innovators can do better or more.

[snip]

Refusion of Arts & Sciences (revisited).  Another IBM deal in Europe underscored an old industry trend that we first identified in 1994 - a refusion of arts and sciences that the silicon is facilitating.  When the sponsors of the Mare Nostrum data center, the #1 supercomputing site in Europe, based in Barcelona, Spain, gave IBM the specs as to how they wanted it built, they insisted it had to be "beautiful" as well as energy efficient.   And that's what they got eventually (right).

[snip]

Retail Store Solutions.  IBM's Retail Store Solutions is perhaps one of the best kept secrets inside the Big Blue.  It's what was left over from the PC sale to Lenovo in 2005.  Yet it's one of the fastest growing businesses in IBM, and the only one in which Big Blue actually touches consumer markets directly.

[snip]

SMB.  Speaking of SMB, that was one of the promising seedlings identified in our last year's "State of the IBM Union" report.  And its importance seem to rise this year when the IBM chairman and CEO said at the Partnerworld conference in St. Louis in early may that this is the company's most important growth opportunity (see "IBM: Lowering Center of Gravity," May 2007).

[snip]

Some Strategic Inconsistencies?  When Sam Palmisano said at the Bangalore June 2006 conference for financial analysts that the company would "exit any business that is a commodity business," and that IBM would "not rationalize for synergy" (as Lou Gerstner did by hanging on to the low margin PC business for so long), we applauded the new IBM strategy.  For, we saw it as a statement about emphasizing "quality over quantity" (left chart).  And that's something that we saw as attractive both from the business fundamentals, as well as stock market viewpoints.

[snip]

Summary: Innovation, Innovation...

Innovation, innovation... and then more innovation.  That was basically the theme of Rod Adkins', STG's chief technology officer's (right) summary of IBM's hardware strategy, as were the earlier presentations by Dr. Meyerson and Zeitler.  The three top IBM hardware executives marshaled out  numerous examples of where IBM's inventions, either in-house or in collaboration with clients, helped change the world and the shape of the IT industry.

[snip]

And so, the beat goes on... faster, smaller, cheaper, cooler is winning the day again, but  in a new way, for IBM and its customers.  Adkins saw the current period as the "virtualized" era, coming on the heels of "distributed" and "centralized" periods during the first 50 years of the computer industry (left chart).  And the STG general managers, whom Zeitler assembled on stage for discussion and a Q&A with analysts and consultants put their own individual spins on the IBM innovation theme.

[snip]

"You've got to be a foundry of innovation to help change the world a little," as you saw earlier IBM's Samson declare. 

Foundry and an art workshop as well.  For, a refusion of arts of sciences is indeed taking place and taking hold of the IT world 13 years after we first discerned it.  Leonardo da Vinci would be pleased.

[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 Bulletin, along with many tables and charts that back up our forecast.  

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Happy bargain hunting!

Bob Djurdjevic

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