IBM Corp’s acting Chief Financial Officer Larry Ricciardi broke with a long tradition when he announced the company’s second quarter results in late July (CI No 3,208): there was no face-to- face briefing with the fund managers and analysts who follow the stock so closely. Instead, he opted for a combination of web-site charts and a teleconference. It was a format which seemed to work. IBM faced few tricky questions, the briefing was quickly over, and the stock showed little reaction to what, closer analysis suggests, is a worrying set of numbers. The headline figures were undramatic: Revenues rose 3.8% to $18.9bn, with net income of $1.45bn, up from $1.35bn a year ago. But in spite of these increases, sales and profits for several core, strategic businesses, ranging from consumer personal computers, to mid range and high end systems and server software, were flat or down. Further, net margins in its fastest growing businesses – such as computer services – remain low. One IBM watcher who is not impressed by IBM’s current condition is Bob Djurdjevic, president of Annex Research of Phoenix, Arizona. He concludes his latest note on IBM saying IBM is a far riskier investment now than it has ever been [in relation to the stock price]. But Wall Street is unconcerned. This is in part because IBM’s chief executive Louis Gerstner has, ever since he first took over as chief executive, skilfully managed analyst expectations, so that the final figures never seem to disappoint.
Shore up IBM’s standing on Wall Street
Financial engineering in the latest quarter helped to shore up IBM’s standing with Wall Street. First, IBM has bought back a large number of shares and reduced the number in circulation; this has increased the all-important earnings-per-share figure. And second, IBM has taken a number of measures – such as moving manufacturing abroad – to reduce its tax bill and increase its net profit figure. Without tax savings, profits were flat. Gerstner professed himself largely satisfied with the results, adding somewhat glibly that they show the ongoing strength of our broad business portfolio. A skeptic might say that this means the company is large enough and diverse enough for problems to remain hidden – for a time, at least. There are two areas of concern which, if they do not show improvement soon, will surely start to drag down IBM’s currently healthy profile in the computer industry. The first is hardware sales, the second is profit margins. None of IBM’s four key hardware product lines is performing particularly well – especially given the strong growth and profits of rivals such as Compaq Computer Corp, Sun Microsystems Inc and Hewlett Packard Co. In each product group, the problems are different. The S/390 parallel mainframes are selling well, but prices are still falling fast, leading to flat revenues. More worrying were sales of the AS/400 midrange system and the RS/6000 Unix servers and workstations, both of which declined. Although IBM argues that the slowdown is partly due to product transition, with buyers waiting for new models, it is clear that overall, both are losing market share. It is difficult to escape the conclusion that the strong advance of Intel Pentium-based systems running Microsoft’s NT is playing its part. While IBM’s high end PC and PC server sales increased in line with the industry, consumer sales fell, suggesting the momentum behind its recovery in PCs has again faltered. Falling hardware sales have an immediate and substantial knock-on effect on software sales, especially for the mainframe and AS/400. Although IBM has not given details, overall software sales fell 4% in spite of strong increases in its two bright spots, the Tivoli systems management division and the Lotus Notes/Domino division. A second problem for IBM is that its costs are still too high. As Annex Research points out, IBM’s most profitable segments are declining or flat. Fast-growing services, meanwhile, has a pre- tax margin of just 3%, although this will improve when the growing business stabilizes. IBM’s hardware business, too, is barely profitable with pretax margins of 5%. Annex notes these margins are below those of giants McDonald’s or Wendy’s. With its services business now the largest in the world, and still growing fast, a strong balance sheet, and several hot software businesses, IBM is far healthier than when Gerstner took charge in 1992. But the figures do not lie: when it comes to making, and profitably selling computer systems, IBM is losing ground. It remains to be seen if this is permanent or if its other businesses can compensate.
