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IBM (NYSE:IBM) competes with Oracle (NYSE:ORCL) and Red Hat (NYSE:RHT) in the middleware software market. IBM charges for new software licenses, maintenance of existing licenses and services associated with its popular middleware software such Websphere Application Server, Lotus and Information Management.

Middleware software consists of a set of enabling services that allow multiple processes running on one or more machines to interact across a network. The phenomenal growth of the internet has resulted in increased demand for middleware software.

Middleware software becomes crucial for the IT resources of major businesses because: a) It has the ability to overcome interoperability issues facing different types of databases, b) Enables transparent access to numerous user applications.

Below we discuss the importance of IBM’s middleware division to its stock, and the reasons for our positive outlook for new middleware licenses.

Most Valuable Part of IBM’s Stock is Middleware Software

We estimate middleware software to constitute 41% of the $164 Trefis price estimate for IBM’s stock. Middleware is a high-margin business for IBM compared to its service and hardware businesses. Middleware contributed about 23% of IBM’s total revenues in 2009, while its contribution to its total profit was nearly 35%.


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IBM Middleware License Revenue to Grow to $7.7 Billion

Revenues associated with software sold to large businesses are usually based on a mix of new license sales and maintenance (recurring) revenues from existing customers. IBM typically derives around 30% of its middleware revenues from new licenses sold. IBM license revenues grew from $3.8 billion in 2005 to $5.2 billion in 2009.

We expect middleware license revenues to reach $7.7 billion by the end of the Trefis forecast period, driven by the following factors:

1. Websphere and Information Management software will drive license revenue growth

IBM’s Websphere and Information Management software are in demand by many large businesses. Despite the decline in the macroeconomic environment, these two middleware products showed strong demand that led to small growth in license sales. We expect these two products will lead growth for middleware license revenues in the future.

2. Upgraded and packaged Lotus software offerings will boost sales

Lotus email software revenues declined in the past mainly because enterprises were more inclined toward Microsoft’s email client. IBM is now integrating its database DB2 with Lotus offerings, and this will make it easier for small and medium size businesses (SMBs) to maintain their IT operations with no extra charge levied for DB2.

IBM has extended its Lotus offering to LotusLive, a web-based cloud computing and Software as a Service (SaaS) that delivers scalable, security-rich email, web conferencing and collaboration solutions. LotusLive has close to 18 million users across enterprises as of now, with another 200 clients planning to offer LotusLive through their cloud services.

3. IBM leads the middleware market with nearly 50% share. The company’s large middleware client base and the “sticky” nature of many middleware clients makes it harder for Oracle (ORCL) and Red Hat (RHT) to win share quickly.

You can modify our forecast above to see how IBM’s stock would be impacted if its middleware license revenues were to grow slower than we forecast.

Disclosure: No positions

Source: Is IBM's Future in Middleware Software?