Buy IBM To Benefit From Rising Software Profitability

| About: International Business (IBM)
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IBM Corp. (NYSE:IBM) reported its 3rd quarter earnings yesterday, and met analyst earnings estimates. The company has beaten analyst targets in the last four quarters. The revenue targets for the quarter were missed by approximately 3%. The main reason behind this miss was the adverse impact of currency fluctuations. The growth in the software side of business and increasing margins make us bullish on IBM.


Analysts were expecting EPS of $3.62 and revenues of $25.4 billion for the quarter ending September. Today, the company reported its 3Q2012 earnings; revenues were $24.7 billion, while EPS were $3.62. In more good news for investors, the company announced that it is maintaining its previous full year $15.1 EPS guidance, a 12% YoY increase. The primary reason behind increased earnings was the improvement in margins, which had a net profit impact of $17 cents per share.

Geographical Performance:

According to the company's disclosures, its sales from North America saw a 4% decline. The North America software segment showed a 4% growth, but it was offset by a negative double digit decline in the hardware segment. Japan and European sales were approximately flat QoQ. The revenues and BRIC saw an 11% growth during the quarter, with India, China and Russia being the largest contributors to growth.

Segment Performance:

The combined revenues for the quarter from both service segments were $14.5 billion. Global Technology Services contributed $9.9 billion to total service revenues, showing a decline of 4% QoQ. The revenues from the Software segment were $5.8 billion, showing a decline of 1%. There was a significant YoY increase of 6% in income from this segment and which was reported at $2.4 billion for the quarter. The largest decline was 13% in the Systems and Technology segment. The company reported segment revenues at $3.9 billion for the quarter.

Current Fluctuation:

Exchange rate fluctuations resulted in a 3% revenue decline. Revenues in the quarter went down by 5%, but according to the company disclosures, at constant currency, they were down only 2%. Moreover, if RSS divesture is ignored, the decrease is further reduced to 1%. Moreover, during the quarter, operating expenses and other income went down by 10% due to currency fluctuations.

Smarter Planet:

Smarter Planet is a solution offered by IBM. The company provides integrated solutions for enabling the implementation of different systems such as smart grids, water management, traffic congestion solutions, etc. The Smarter Planet initiative showed a growth of 20%, and remains a future growth area for IBM. This growth in the software side of the business is one of the primary reasons behind improved margins.

Analyst Opinion:

In the last three quarters, not a single analyst has had a 'Sell' or "Underperform" rating on the company. Analyzing the opinion of 27 analysts reveals that 11 have a buy or strong buy rating on the stock, with the remaining giving a hold rating.


One of the reasons behind the less than expected performance in some segments is currency fluctuation. At constant currency, the company has shown 7% growth for the year. The stock is currently trading at a forward P/E of 12x, which is at a 20% discount to the NASDAQ's P/E of 15x. As we discussed in our previous IBM update, the stock can trade at its 5-year average P/E of 14x, which gives it a target price of $233; meaning a 16% upside. Moreover, the increase in margins and increase in revenues from the software segment make us bullish on IBM.

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

Business relationship disclosure: The article has been written by Qineqt's Technology Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.