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  1. Technology
November 4, 1993

THE HOLY GRAIL OF SERVICES LOOKS MORE LIKE A POISONED CHALICE FOR IBM

By CBR Staff Writer

IBM Corp shares have finally broken sharply up out of their low-to-mid 40s trading range of the past year following an upgrade from long-time bear Donaldson Lufkin & Jenrette analyst Thomas Rooney. One trader called IBM a stock that has been beaten to death and finally has someone to come out (with research) on them, adding that the shares are breaking out of a technical range. IBM, which rose over a point late on Monday, rallied three points more to $50.75 in early trading on Tuesday. Rooney raised his rating on IBM to very attractive from neutral and raised 1994 and 1995 estimates. I think there is a feeling the stock has hit bottom – that there is not much downside and there is an upside. It is a question of timing, Bill Milton of Brown Brothers Harriman, who last week upgraded IBM to neutral from sell, told Reuter. Milton said Rooney is a long-time IBM bear. When he goes positive, people listen, Milton said.

Skyhooks

Donaldson Lufkin raised 1994 estimates to $2.25 per share from $1.50 and 1995 to range between $3.50 to $4.00 from $2.50. Milton said IBM last week reported third quarter results which were markedly better than expected, leading him to expect a sizeable fourth quarter profit, which will be enough to bring the full year above break-even, excluding restructuring charges. Jay Stevens of Dean Witter still estimates that IBM will lose about $0.25 per share for 1994, but said IBM’s most recent quarterly results were strong in light of a seasonally slow third quarter. Well yes, that’s all very well, but where is the profit to come from? Just like the Tokyo market before it finally cracked, IBM’s turnover seems to have been held up by skyhooks for the past year or so, and it is extremely hard to discern where all the volume is coming from. Not mainframes the skids are very definitely under those; in good years, the AS/400 should perform, and in very good years, the personal computer business may make a very modest contribution, although margins there are painfully slim. The RS/6000 may one day contribute a little, but it is still a tiny business for a $60,000m a year company. Disks have been a vast disappointment, the external chip business is still vestigial, and that leaves software and services. IBM has to lose software revenues as mainframe sites go dark, and it is beginning to suffer seriously in the AS/400 market because its software charges are perceived as much to high by users. That leaves services. All those magnificently impressive facilities management contracts that IBM has won make it quite clear that the company can win business – but what kind of company is prepared to entrust anything other than routine tasks like payroll to an outside party? Only those so desperate to cut costs that it is doubtful that they will even be around for the full term of the contract.

Stretches credulity

The idea that IBM – or Digital Equipment Corp or Compagnie des Machines Bull SA – can conduct a services business better and more profitably than companies that have been at it for years and years and years, like Electronic Data Systems Corp, Cap Gemini Sogeti SA, Computer Sciences Corp, stretches credulity well beyond breaking point. Many of the lower-level services such as disaster recovery – are so straightforward that almost anybody can enter the business, causing big trouble for the established players even if they fail to make any money out of it, and fold in a year or two. One AS/400 disaster recovery shop in the UK reports that it has encountered nine different competitors in various bids in the UK this year – and that prices for AS/400 recovery services have declined 25% to 30% a year for the past three years, with little sign that that rate of decline will slow any time soon. Again in the UK, Richard Holway’s System House publication is forecasting that while the software and computer services business experienced double digit percentage growth throughout the 1980s, it came to a shuddering halt in 1991, and growth across Europe this year looks like coming out at about 2% – less than the rate

of inflation in most countries. The researchers are forecasting a compound annual growth rate of 11% in the UK software and computer services market between now and 1997, with software maintenance and facilities management the fastest-growing sectors – but all that means is that the market is going to become even more competitive as would-be players see which way the wind is blowing. IBM faces a whole string of problems in trying to compete in this business. A major one is that it has lost so many of its best people, which means that if it is going to be successful, it will have to go out and buy the skills it needs which means yet more costly lay-offs of the inapropriate personnel with which it is stuck. Another is that its core skills are rapidly sailing past their sell-by date: all its skills are in monolithic mainframe systems: it has no internal client-server expertise at all unless you define a dumb 3270 tube attached to a 370 as a client. Until very recently, most top IBM managers in the US didn’t even have a personal computer in their offices – they neither trusted nor understood the things. Which meant that it didn’t – and still doesn’t really understand the new computing order that swept all before it in the 1980s, and ensured that the 9370 would be such a commercial disaster.

Counsel of dispair

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Putting all that together, a plunge into services looks like a counsel of despair for IBM – but what else can it do? The fact that Lexmark International Inc is still around and appears to be thriving suggests that the idea of floating off much of the business into separate independent companies, leaving IBM with the AS/400, looked like the least bad solution – and stripped of the IBM overhead, the Personal Computer Co, which shows signs of getting things right at last, might even turn into an attractive property as an independent entity. As it is, it looks like nothing more than a source of profitless volume for IBM – and services look like the same thing in spades. IBM’s tragedy is that the world no longer needs the company to continue to exist in anything like its present form, and the least bad solution to its manifold problems now looks to be to break itself up, to the great benefit of its shareholders, its surviving customers, and the industry it did so much to help to create.

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