Cover Story: The New IBM by Leslie P. Norton
Highlighted companies: International Business Machines Corp. (IBM), EMC Corp. (EMC), Microsoft Corp. (MSFT), Dell Inc. (DELL), Hewlett-Packard Co. (HPQ), Citigroup Inc. (C), Sun Microsystems Inc. (SUNW), Siemens AG (SI), Accenture Ltd. (ACN), Infosys Technologies Ltd. (INFY), Wipro Ltd. (WIT), SAP AG (SAP),
Summary: Barron's cover story takes a bullish stance on International Business Machines Corp. (IBM). CEO Samuel Palmisano, who few thought would radically part ways with his predecessor Louis Gerstner when he took over in 2002, is doing his best to reinvent the giant and transition it from a hardware/mainframe focus to a middleware producer which can make big dough with its exceptional software margins (85%), followed-up with client services. Some key points:
Palmisano: "We have a top share in servers and Linux, No. 1 in blade servers, which is a huge growth area... No. 1 in supercomputing, No. 1 in SOA... We're No. 1 in middleware... IBM is a stronger company today than it was four years ago, with stronger margins, solid cash and earnings." Barron's: You don't need a computer to know what that trend could do for IBM's shares.
- 2006 earnings are expected to grow 12%, and 2007 by another 9% ($5.98 and $6.54).
- Shares trade at 15x earnings vs. 25x for EMC Corp. (EMC), 23 for Dell Inc. (DELL), and 20 for Microsoft Corp. (MSFT).
- Its $10b cash on hand can be and has been used to boost earnings through swallowing up smaller software companies and speculative investments such as last month's Citigroup Inc. (C) partnership in China's Guangdong Development Bank.
- A decade ago most IBM software ran on its mainframes. Today it's the world's largest middleware vendor through brands WebSphere, Lotus, Tivoli, Rational and DB2 brands. Its legacy software, such as the operating systems for IBM mainframes and servers, "don't blow anyone's doors off," but are still big money makers.
- Its middleware helps companies implement "Service Oriented Architecture" [SOA], a buzzword for the growing trend to make computer systems more flexible and adaptable to changing business needs. IBM sells over 3x more SOA products and services than anyone else.
- Its traditional services department has been hit by competition, particularly Indian rivals which low-cost services. IBM has restructured its service unit, and plans to invest $6b in India, possibly acquiring another firm to go along with its purchase of outsourcing company Daksh. This quarter IBM won a $300 million contract with Scotland's public health service, an $863 million deal with the State of Texas, and is expected to sign a 10-year $8.45 billion contract with Siemens AG (SI) to modernize technology for the German military.
- Its "cash-cow hardware division keeps ticking," with Q3 growth up 8.8% (versus 5% in 2005) from higher mainframe revenues and gains in IBM's Technology Collaboration operation.
- IBM processors are at the core of all major videogame consoles, including Sony's (SNE) new PlayStation 3. Bob Djurdjevic of Annex Research predicts that Technology Collaboration, its R&D and semiconductor-design unit, "will become so large that it deserves comparison to IBM's shift to services several years ago."
Related: The Ten Best Tech Stocks Of All Time • A Big Day For Big Blue • IBM's Recent Quarter Wasn't All That Great - But Its Valuation Still Is • IBM: India Revenue Growth Strongest Among BRIC Countries • IBM Stands Tall: Blue is Big Again • Despite Sluggish PC Sales Big Blue Remains a Good Bet • IBM Q3 2006 Earnings Call Transcript
What's in His Wallet? by John Kimelman
Highlighted companies: CompuCredit Corp. (CCRT), Capital One Financial Corp. (COF), RenaissanceRe Holdings Ltd. (RNR), Citigroup Inc. (C), Bank of America Corp. (BAC), JPMorgan & Chase Co. (JPM), Wachovia Corp. (WB), Tennessee Commerce Bancorp (OTC:TNCC)
Summary: Tom Brown's Second Curve Capital hedge-fund invests exclusively in financial services stocks, and has generated 20% yearly returns since its start in May 2000. Stocks mentioned:
Related: Bank of America: Impressive Numbers Prove We Were Wrong -- Barron's • Bank of America, Citibank Takeover Targets On Paper Only • Banking ETFs May Be Short Candidates In This Rate Environment • Two Midcap Bank Stocks Worth a Look • Insurance Stocks: Wall Street's Biggest Secret
- CompuCredit Corp. (CCRT): A sub-prime lender that instead of focusing on credit cards, offers payday and automobile loans. Brown concedes that sub-prime lenders may be vulnerable to economic slowdowns, but sees risk assessment as a far more critical determinant. Calls CCRT's $700m of excess liquidity a "wild card" that could be used for earnings growth. Shares trade at 6x '08 earnings, and he expects earnings growth of 20%+.
- Capital One Financial Corp. (COF): Within a year credit cards will be less than half of its earnings. It trades at 8x '07 earnings. "Next year it will be perceived as a rapidly growing diversified financial institution."
- RenaissanceRe Holdings Ltd. (RNR): 2004-5 hurricane devastation led to a dramatic repricing in the reinsurance industry that will drive 20%+ growth for another couple years. It trades at 6x 2007 estimates, which Browns says are too low.
- Citigroup Inc. (C) Bank of America Corp. (BAC) JPMorgan & Chase Co. (JPM) Wachovia Corp. (WB): Due to their size, they stand little chance of having a serious earnings shortfall, but huge earnings beats are equally unlikely. If Citigroup management starts taking action like selling off some businesses, it could go up 10-15%.
- Regional banks: He's short the sector, particularly banks that bet on falling interest rates and steep yield-curves. He doesn't see the yield-curve steepening in the coming year. He likes Tennessee Commerce Bancorp (OTC:TNCC) because of its focus on the small business customer that "more than compensates for its exposure to the yield curve -- they can grow their earnings rapidly despite the difficult interest-rate environment."
At Duke, A Powerful Idea by Jack Willoughby
Highlighted companies: Duke Energy Corp. (DUK)
Summary: Duke Energy's planned January spinoff of its natural-gas operations into Spectra Energy is 'turnaround wiz' Chairman Paul Anderson's brainchild. He hopes the split will bring "full value" for its underappreciated gas assets, including 17,500 miles of pipeline. The two businesses trade differently: (1) Gas companies trade for multiples of cash flow and electrics for multiples of earnings. (2) Gas concerns command richer valuations, in part because they make use of master limited partnerships which allow them to pass tax-free cash through to investors. (3) Spectra faces fewer regulatory hurdles than electric utilities, and expansion opportunities abound due to underinvestment in pipelines and storage, and rising demand. Duke shareholders are to receive one Spectra share for every two shares of Duke common, meaning they would get Spectra stock for $8 per share. Analysts believe it could trade for double. According to analyst Nathan Judge, Duke's assets are worth about $37 a share, 17% above the recent stock price of $31. Utilities analyst John Bartlett calls Duke, "an excellent way to capitalize on both the need for new energy infrastructure and the potential for a higher valuation as the market recognizes the strength of the underlying utility business."
Barron's bottom line: After the spinoff, Duke could trade for $23 and change; Spectra, for $16.45.
Related: Electric Utilities 3Q Earnings Preview; Time To Go Long Electricity; Jim Cramer's Take On DUK
TECHNOLOGY TRADER: Microsoft's Bold Voyage Begins by Bill Alpert
Highlighted companies: Microsoft Corp. (MSFT), Cisco Systems Inc. (CSCO)
Summary: Shares of Microsoft Corp. (MSFT) are up 35% since June to $29 as investors anticipate big upgrade revenues from Vista and Office 2007. Shares presently trade at 20x 2006 expected cash flow of over $15b. While some investors are skeptical that Vista can deliver the growth bulls think it will, Barron's likes last week's launch, the fact that profit margins on Vista and Office exceed 60%, and that forecasts are conservative in estimating only 50% of its installed base will upgrade. New server-based voice communication and collaborative software look to be stiff competition for Cisco Systems Inc. (CSCO), and it seems MSFT will finally start turning a profit on Xbox 360. The company plans to use up to $40b of its massive cash stash in stock buybacks, which combined with a rise in revenues from its new products could get per-share cash-flow up to 15%, and push shares into the mid 30s.
Related: Microsoft's Vista Goes On Sale To Corporations (yawn) • Survey Shows There May Be Hope for Microsoft's Zune After All • How Broken is Microsoft? • PS3, XBox or Wii: Pros and Cons of Gaming Consoles • Microsoft F1Q07 Earnings Conference Call Transcript
TECHNOLOGY TRADER: Dell by Bill Alpert
Highlighted companies: Dell Inc. (DELL), Hewlett-Packard Co. (HPQ), EMC Corp. (EMC)
Summary: Friedman Billings Ramsey hardware analyst Clay Sumner asserts in a report published Friday that Dell (DELL) has been manipulating its earnings by under-compensating for warranty costs; he claims Dell EPS figures have overstated earnings by $0.02-$0.08/share in five of the past 12 quarters. He accuses Dell of using warranty accruals to custom-fit earnings -- citing that while warranty claim rates have been relatively stable, accrual rates have varied wildly. Dell, he says, tends to under-accrue during poor seasons and over-accrue in better times, but the overall trend since Q3 2003 has been toward under-accrual. Warranty costs are currently 46% of its warranty reserve, well above Hewlett-Packard Co.'s (HPQ) 26% and EMC Corp.'s (EMC) 13%, and that Dell with its large corporate sales base (85%) should be more in-line with EMC that with HP. With actual claims rising steadily, he warns earnings restatements may be on the way.
Related: Dell Over-Stating Profits, FBR Analyst Says • Seagate CEO Disses Dell and Creative • Is DELL Optimism REALLY Warranted? • A Dell Long Play: Buy the Stock Only When it Comes to You • Analysts Still Skeptical On Dell • Dell Q2 2007 Earnings Conference Call Transcript
Tracking the Smartest Money by Andrew Bary
Summary: Barron's identifies five top-notch hedge funds whose investment moves are closely watched by the industry, revealing their top holdings and some recent transactions:
Related: Harry Kat and the Art of Replicating Hedge Fund Performance • Hedge Funds May Drive Year-End Nasdaq Rally • Can Retail Investors Profit From Hedge Fund Access? • Steven Drobny Speaks Out About Hedge Funds • Activist and Alternative Fund Managers Often Do More Damage Than Good • Hedge Funds Are Risky Business: It's Surprising Anyone Ever Lost Sight of That
- David Tepper's Appaloosa Fund: (1) Oracle Corp. (ORCL) (2) Micron Technology Inc. (MU) (3) Applied Materials Inc. (AMAT). Other big holdings: Cisco Systems Inc. (CSCO), Microsoft Corp. (MSFT), Texas Instruments Inc. (TXN), NASDAQ 100 Trust Shares ETF (QQQQ), AMR Corp. (AMR), UAL Corp. (UAUA), and Continental Airlines Corp. (CAL). Notes tech stocks aren't the bargains they were earlier in the year.
- David Einhorn's Greenlight Fund: (1) Ameriprise Financial Inc. (AMP) (2) Microsoft (3) Hospira Inc. (HSP). In May Einhorn talked about his affinity for Microsoft, saying that buying Microsoft at $23 was like getting Alex Rodriguez for a merely average price in a fantasy-baseball draft.
- Steve Mandel's Lone Pine Capital Fund: (1) Brookfield Asset Management Inc. (BAM) (2) Google Inc. (GOOG) (3) Comcast Corp. (CMCSA). Mandel cut his Google position by 25% in Q3, suggesting it may be getting too rich for him. He added to Comcast and Qualcomm Inc. (QCOM), sold Research In Motion Ltd. (RIMM) and America Movil SA de CV (AMX), and established a position in Schlumberger Ltd. (SLB).
- Ed Lampert's ESL Investment: (1) Sears Holdings Corp. (SHLD) (2) AutoZone Inc. (AZO) (3) AutoNation Inc. (AN). The three comprise Sears Holdings' CEO's entire portfolio. Barron's says many hedge-fund managers own Sears out of admiration for his retailing skills.
- Activist investor Carl Icahn: (1) Time Warner Inc. (TWX) (2) ImClone Systems Inc. (IMCL) (3) American Railcar Industries (ARII).
THE TRADER: Retail Stocks by Vito J. Racanelli
Highlighted companies: Tiffany & Co. (TIF), The Home Depot Inc. (HD), Best Buy Co. Inc. (BBY), Circuit City Stores Inc. (CC), Wal-Mart Stores Inc. (WMT), Federated Department Stores Inc. (FD)
Summary: Despite TV coverage of shoppers stampeding through malls, retail stocks were down last week; the internet group was down 7% while department stores fell 4%. According to Lehman Brothers' chief technical analyst, Jeffrey deGraaf, retail stocks tend to peak in the days that straddle Thanksgiving, then drifting down through most of December before Christmas. Generally it's better to wait until just before Christmas to play the sector; its long-term outlook is neutral. Stocks noted: Tiffany & Co. (TIF) -- showing a good technical pattern. The Home Depot Inc. (HD) -- neutral. Best Buy Co. Inc. (BBY) and Circuit City Stores Inc. (CC) -- among the weakest patterns in the group. Department stores -- look good. Wal-Mart Stores Inc. (WMT) -- mediocre. Federated Department Stores Inc. (FD) -- it reported sizzling sales last week, and if it goes down with the sector, it will be a buying opportunity in a couple weeks.
Related: November Retail Sales Disappoint; Federated and Target Are Bright Spots • More Bad Data From The National Retail Federation? • Retail Sector Has Much To Be Thankful For - Sales Up Nearly 20% • Will Consumer Woes Kill The Pre-Thanksgiving Rally? • Retail By the Numbers • Rob Black's Retail Stock Report
Weak Dollar by Vito J. Racanelli
Summary: Few Americans like the recent beating the U.S. dollar has taken; half of this year's 8-10% slide has come in the past month. A sustained drop could lead to the Fed raising interest rates. Will it continue? Hard to say, but with interest rates and growth rising in most other parts of the world, unlike the U.S., its drop may be sustainable. For one domestic group, American multinational corporations, who derive a good part of their revenues from overseas, this is good news. Bank of America's Joseph Quinlan says a "sustained, broadly based decline" in the dollar could provide a big earnings boost for many U.S. multinationals, namely: Intel Corp. (INTC) leads the Dow components in overseas exposure with 85% non-domestic revenue. Coca-Cola Co. (KO) (71%), ExxonMobil Corp. (XOM) (69%), McDonald's Corp. (MCD) (66%), Hewlett-Packard Co. (HPQ) (65%), International Business Machines Corp. (IBM) (62%) and 3M (MMM) (61%).
Related: The Dollar 's Impact on the Stock Market • China: What to Do with Foreign Reserves At $1 Trillion and Counting? • Dollar Troubles • Fill Your Basket With Emerging Market Currencies • Dollar Freefall? Maybe Not • Options Trader: Monday Morning Ideas
Sunny Skies for Insurers by Jim McTague
Highlighted companies: Aspen Insurance Holdings (AHL), Endurance Specialty Holdings Ltd. (ENH), Axis Capital Holdings Ltd. (AXS), Montpelier Re Holdings Ltd. (MRH), RenaissanceRe Holdings Ltd. (RNR), ACE Ltd. (ACE)
Summary: Many property and casualty insurers will likely see triple-digit earnings growth this year, after recovering from weather catastrophes that dropped profits in 2005. Shares have rebounded nicely, although more gains lie ahead, particularly for the industry's biggest players. Because the insurers lost so much in 2005, regulators let them hike rates sharply and increase deductibles. With a mild 2006 storm season behind them, some analysts feel shares are now fairly priced. But others say that even assuming an average rate of catastrophes, return on equity could increase 18-20% in 2007 due to the higher premiums, driving share prices up 25-30%. Assuming no major earthquakes, Rohan Pai and Alain Karaoglan of Deutsche Bank say earnings for the next three quarters should be excellent. They like Aspen Insurance Holdings (AHL), Endurance Specialty Holdings Ltd. (ENH), Axis Capital Holdings Ltd. (AXS), Montpelier Re Holdings Ltd. (MRH), and RenaissanceRe Holdings Ltd. (RNR). Even the less enthusiastic agree that bigger companies like ACE Ltd. (ACE) still have some upside.
Related: AIG Blows Away Forecasts After Hurricane-Free Season • Insurance Stocks: Wall Street's Biggest Secret
Did you know? You can get our One Page Barron's Summary emailed to you every week. We don't spam, never sell email addresses, and there's easy-unsubscribe in every email. Sign up here.