Richard T. Williams of Jersey City-based ICAP recently sent a note to clients in which he reiterated his firm's sell rating for International Business Machines (NYSE:IBM). The note follows IBM's announcement that it will purchase IDS player Internet Security Systems (ISSX) for $1.3 billion. Excerpts from the note follow:
• Ever hopeful bankers see a coming M&A boom as Big Blue re-enters the App space it exited at great cost pre-Y2k. Infrastructure and Services remain key to this story rather than apps which would spawn channel conflicts. IBM is a leading Web Channel vendor, selling software infrastructure that enables e-business for businesses.
• ISS Deal – IBM surprised the Street by announcing an agreement to buy Security vendor ISSX for $28/share. The deal might sound like a sea change in IBM’s strategy but we strongly doubt it. Mgmt. indicated that ISSX fit as the final big piece of its Security Infrastructure suite and that nothing has changed in its approach to provide tools, services and infrastructure in order to manage and provide corporate customers turn key or managed solutions to developing Web Channel needs. ISSX provides IDS, or intrusion detection solutions, which help network administrators to spot hackers and stop them from damaging or breaching secure digital assets. IBM views their Security suite capabilities as being largely complete.
• Strategy Unchanged – The ISSX deal set off a great deal of hopeful speculation that IBM would effectively buy the entire software space, but then again the rumors have had IBM buying endless numbers of companies simply because it has a lot of cash. The key to virtually all of IBM’s deals goes back to a decision pre-Y2k to exit applications businesses at great cost. Mgmt decided to bet its fortunes on Services and Consulting plus Infrastructure tools rather than customer facing Apps. The Street must have missed it when that strategy was announced because we hear endless discussion about how IBM is going to buy just about every software player in the space. Clearly buying an Apps player like Cognos (COGN) or McAfee (MFE) would bring IBM into direct conflict with significant portions of its ISV channel, the source of major portions of its software revenue stream. So unless a deal can subsume the losses of ISV sales, then we look at it with a jaundiced eye. With literally thousands of ISV partners, IBM like rival BEA Systems (BEAS), cannot be seen to compete with its partners and expect to survive the attempt. That is why BEAS had to sit by and watch its Web Channel ambitions fade away while rivals Oracle (NYSE:ORCL), SAP (NYSE:SAP) and Microsoft (NASDAQ:MSFT) moved in to take over the lead. It could not enter the Apps space, period! IBM is in much the same position; hence deals will be Infrastructure only.
IBM 1-yr chart: