IBM: Little Hiccups In Transformation Strategy

| About: International Business (IBM)

Shares of information technology company IBM fell after the close Tuesday as the company released its first quarter results. Shares trade 2.3% lower approaching the $200 mark.

First Quarter Results

The world's biggest computer-service provider reported a 7% increase in its GAAP earnings to $3.1 billion. Earnings per share were up 13% as the company has repurchased a substantial amount of shares over the last year.

Revenues came in flat at $24.7 billion. The software division reported a 5% increase in its revenues to $5.6 billion while its main service division saw a 1.7% increase in revenues to roughly $10 billion. The systems and technology division reported an unexpected 7% revenue decline to $3.7 billion due to weakness in its hardware division.

Shares react negatively on the "soft" revenue headline. Heavy investments in the analytics and cloud-computing business are relatively marginal and yet have to pay off big time. The service backlog fell $2 billion to $139 billion, indicating possible further revenue weakness in future quarters. Another worrying sign is the fact that revenues in Europe, Middle East and Africa fell 2% on the year to $7.6 billion on the macro-economic outlook and governments constraining public budgets. CFO Loughridge attributes the relatively lower revenue growth due to a very strong quarter last year.

"In the first quarter, we drove strong profit and earnings per share growth. We delivered another excellent software performance, expanded services margins, and continued the momentum in our growth initiatives," according to CEO and President Rometty.

IBM slightly boosted its operating earnings target for 2012 from $14.85 in January to at least $15 per share. The guidance slightly beat analyst consensus around $14.92

For 2015 CEO Rometty reiterated the goal to target operating earnings north of $20 per share. Furthermore IBM hopes to boost revenues by an annual $20 billion and intends to make acquisitions for at least $20 billion.


IBM ended its first quarter with $12.3 billion in cash, equivalents and marketable securities. It operated with $32.1 billion in short and long term debt for a total debt position of roughly $20 billion. Valued at roughly $235 billion the company trades at 2.2 times annual revenues and 15 times 2011's earnings.

The company trades at a discount compared to pure play software competitors Oracle (ORCL) and Microsoft (MSFT) which trade at 4.0 and 3.7 times annual revenues, respectively. It trades at a premium compared to its hardware counterparts Dell (DELL) and Hewlett Packard (HPQ) both trading at a mere 0.4 times annual revenues.

The company has engaged in a very shareholder friendly strategy and has repurchased some 220 million shares over the last four years, with some 1.17 billion shares outstanding. On top of that investors receive a quarterly dividend of $0.75 per share for an annual yield of 1.5%

Investment Thesis

Shares of "Big Blue" trade around all time highs a little over $200. Shares broke out of a $125 resistance level at the end of 2010 which marked the beginning of a strong rally on the back of improved operational performance, a shareholder friendly strategy and the fact that Warren Buffett bought a sizable stake in the company.

While I appreciate the long term track record of Buffett I think that the strong rally over the last two years leaves little return for the intermediate future. It will take over a decade to transform IBM into a pure software player focused on growth markets like data analytics and cloud-based computing.
While the long term growth prospects of IBM are very rosy, there are very few triggers in the short to medium term to propel shares much higher.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.