Strong Hardware Revenue Growth Does Not Mean Much for IBM’s Stock

IBM (NYSE:IBM) derives the bulk of its revenues from server sales (including system z, system x and system p servers) for which IBM is the global market leader. ^[1] Competitors include other technology giants like HP (NYSE:HPQ), Dell (NASDAQ:DELL) and Oracle (NASDAQ:ORCL) in the server market.

In its most recent Q1’11 earnings, IBM exceeded expectations, posting strong revenue growth in its hardware business segment. However, this improvement has little significance to IBM’s stock value, given the small contribution of the hardware segment to the company’s overall value.

We currently have a $185 price estimate for IBM, about 10% ahead of market price, and estimate that the hardware business represents only 2% of IBM’s equity value.

Low EBTDA Margin on Hardware Business

The hardware business typically has lower margins compared to software or services businesses. While hardware sales made up 18% of IBM’s revenues in 2010, the segment’s contribution to firm’s EBTDA was only 9.8%.

Server business EBTDA margin of roughly 13% in 2010 was much lower than that of IBM’s software, services or financing businesses. While we currently forecast that server EBTDA margin will hover around 13% going forward, the potential upside from this segment is limited given its relatively small contribution to the company’s value. An increase in server EBTDA margin to 15%, for example, would only imply $2 of upside to our $185 price estimate for IBM’s stock.

Despite the low contribution to IBM’s stock value, the server business does hold importance and significant intangible value for IBM, as a number of software solutions and services provided by the firm are based on its installed server base.

See our full analysis of IBM stock here

1. Worldwide Server Market, IDC [↩]