On Tuesday, IBM (IBM) reported disappointing third-quarter results. Though we plan to take a closer look at our valuation assumptions, we don't expect any change to our fair value estimate to be material.
During the period, revenue fell over 5% (down 2% after adjusting for currency), as the tech giant experienced weakness across the board. Revenue in its largest segment, Global Technology Services, fell nearly 4%. Revenue in its next three largest segments-Software, Global Business Services, and Systems & Technology-fell 0.9%, 6%, and 13%, respectively. In fact, not one of its major business segments experienced revenue expansion during the period. Geographically speaking, third-quarter revenue from the Americas fell 4% (down 3% after adjusting for currency), while EMEA revenue dropped 9% (down 1% after adjusting for currency). The company missed top-line expectations by $630 million.
Though gross profit fell only 3.6% (slower than the pace of the revenue decline) thanks to slightly better gross margins, IBM did a poor job of scaling overhead expenses lower as revenue fell. SG&A as a percentage of revenue increased 230 basis points, while RD&E jumped 30 basis points as a percentage of revenue. And backing out the $606 million in other income (non-operating), adjusted income before taxes came in at just above 18% of revenue, down from an adjusted measure of 19.7% during the same period a year ago. If it weren't for its aggressive buyback program, the company would have missed consensus on the bottom line as well (the headline earnings per share number was in line with consensus). Needless to say, IBM's third-quarter performance was about the worst we've seen in some time.
Results were certainly disappointing, but there are some things to still like about IBM. For one, its high-margin services backlog advanced 1% during the quarter, to $138 billion. Growth markets revenue advanced 4% after adjusting for currency, and revenue generated in BRIC countries jumped 11% after adjusting for currency. Business analytics revenue has increased 14% year-to-date, and Smarter Planet sales have expanded more than 20% so far this year. Cloud revenue also continues to perform well. And the firm reiterated its full-year 2012 operating earnings per share expectation of at least $15.10, which we still think is achievable (but mostly because of its buyback program). Plus, IBM continues to be a cash cow, with the firm pulling in $4.5 billion in operating cash flow and $3.1 billion in free cash flow during the period. Though both of these measures were lower than those achieved in the year-ago quarter, they remain robust. Free cash flow was 12.7% of revenue during the quarter, an excellent conversion rate.
All things considered, IBM scores just a 3 on the Valuentum Buying Index (our stock selection methodology), and while its Valuentum Dividend Cushion score is an impressive 3.5, its sub-2% dividend yield leaves us less excited about adding the company to our actively-managed portfolios. We remain on the sidelines. For a read on how we value IBM via our discounted cash-flow process, please click here.