IBM Heads To $225 As Earnings Suppport Its Shifting Focus

International Business Machines (NYSE:IBM) reported flat earnings growth for the first three months of 2012 but registered a 7 percent increase in net income thanks to strong profit margins in the services business. ^[1] In our pre-earnings article we mentioned margins would be driven up by services such as Big Data analytics and cloud computing. We also mentioned focus on emerging markets will play a key role. Q1 is usually the trough in the earnings cycle and revenue growth was as expected. It currently competes with Accenture (NYSE: ACN)  and Hewlett-Packard (NYSE:HPQ) in the enterprise software market.
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What The Numbers Mean

IBM earned $3.07 billion in the first quarter of 2012, which is up from $2.86 billion the same period last year. Revenue however was flat at $24.7 billion, and this is mainly due to shift in its focus from hardware to software and services which has led to a decline in IBM’s hardware and financing sections. A macro factor adding to this slowdown is lower IT spending due to Euro-zone crisis. It reported an increase in revenue from software and services. ^[2]

Business Line Performance

The software revenue grew 5 percent to $5.6 billion and hardware revenue fell by 7 percent to $3.7 billion. Technology services revenue grew 2 percent to $10 billion. This is due to IBM’s focus on services and software which have higher margins. We estimate gross margins at about 41 percent for middle-ware software this is significantly higher than its servers and storage margins which we estimate to be around 13 percent.

Big Data Analytics, The Cloud and Growth Markets to Steer 2012

The outlook for 2012 has been raised as it is expected to focus more on complex value add services like big data analytics and migration of legacy systems to the cloud. It also plans to exit its retail store solutions business and sell it to Toshiba TEC Corp for $850 million. This is a low margin business, and we expect it to sell off other businesses that have low margins. It signed service contracts worth $11.9 billion which is up 15 percent year on year which indicates stronger revenue and earnings in the later quarters. IBM’s growth markets in Brazil, Russia, India and China improved by 9 percent while Europe, Middle East and Africa decreased by 2 percent.

We currently have a $223 Trefis Price Estimate for IBM which is 11% above the current market estimate.

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1. IBM SEC Filing, www.sec.gov, April 17,2012 [↩]
2. IBM Management Discuss Q1 Earnings, www.thestreet.com, April 17, 2012 [↩]