Although I doubt there were many investors still holding serious hope that the first quarter of 2013 was going to end up being a good one for tech companies, IBM (NYSE:IBM) likely snuffed out those hopes with an uncommonly weak quarter. With Big Blue missing for the first time in eight years, and missing across the board, it's pretty clear that business conditions have slowed markedly. Management remains optimistic that business will recover with a strong second half, but even with the big post-earnings decline these shares are not exactly cheap.
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Q1 Weak Across The Top Line
IT spending seems to have hit the rocks in the first quarter, and that showed up across all of IBM's business units.
Revenue fell 5% as reported and 3% on a constant currency basis, as IBM missed the average sell-side guess by almost 5%. The company's largest business unit, services, saw revenue down 4% as reported, with a 2% constant currency decline in Global Tech and flat results in Global Business. Software did a little better, with revenue up 1% on a constant currency basis (down 1% reported), but still missed estimates. Last and definitely least, hardware revenue was down 13% excluding a divestiture.
The news didn't get much better in the profit lines. IBM reported a one-point increase in adjusted (non-GAAP) gross margin, and did slightly beat estimates, but adjusted operating income fell 1% and the company missed the sell-side margin target by more than a point. It's worth noting too that this is the first quarterly miss from IBM since the first quarter of 2005.
SEE: Understanding The Income Statement
Can Everybody Screw Up At Once?
The stereotype on Wall Street is that management teams are loathe to admit any fault, usually trying to pass the buck for poor performance on to “market conditions” or “macroeconomic factors”. Curiously, the opposite seems to be true this quarter in the software market. Management at Oracle (Nasdaq:ORCL), TIBCO (Nasdaq:TIBX), Red Hat (NYSE:RHT) and now IBM all cited “sales execution” issues for weak results this quarter, as deals slipped out of the quarter. I have a hard time buying that, and it seems to me that universal sales slippage may in fact be a sign that customers are nervous about the economy and looking to delay major spending decisions until they see business picking up.
Hardware Looking Scary
IBM isn't a perfect bellwether for tech hardware, but these results should still have investors on edge. The company's weak server performance can't be encouraging for other weak hands like Hewlett-Packard (NYSE:HPQ) or Dell (Nasdaq:DELL). Likewise, IBM's 10% decline in storage may point to more share gains for NetApp (Nasdaq:NTAP) and EMC (NYSE:EMC), but I'd argue that it also suggests weak quarters may be on the way for them as well.
On a more positive note, IBM seems to be continuing its policy of evolving with the times and jettisoning low-potential hardware lines. Specifically, management is looking to sell its x86 server business, and it sounds like Lenovo (Nasdaq:LNVGY) may be the company that buys it. Whether that's a good move for Lenovo is a subject for another day, but it's hard not to respect IBM's willingness to punt businesses with weak future prospects when so many other companies cling stubbornly to their legacy operations.
Are Better Days Ahead In Services?
If there was a positive note in IBM's quarter, it was perhaps the datum point that services signings jumped 44% this quarter to almost $17 billion. That's consistent with the results seen at Accenture (NYSE:ACN) and suggests that IBM is still in a good competitive position relative to the likes of Infosys (Nasdaq:INFY), Cognizant (Nasdaq:CTSH) and so on. It's worth mentioning again, though, that IBM is deliberately looking to turn away less desirable business in an effort to improve margins and returns, so the signings/revenue progression could still be a little lumpy (in addition to the “natural” lumpiness resulting from the economic environment).
SEE: A Primer On Investing In The Tech Industry
The Bottom Line
Even with IBM's stock down hard on this disappointing earnings report, it's not close to value territory for me. I believe that the company can continue to grow its free cash flow at a long-term rate close to 5%, but I wouldn't pay more than $180 for that growth right now. What's more, on a relative basis Oracle, Microsoft (Nasdaq:MSFT), and Cisco (Nasdaq:CSCO) all look cheaper than IBM today, leading me to wonder if investors are a little too enamored of buzzwords like “cloud” and “Big Data” when it comes to IBM.
At the time of writing, Stephen D. Simpson owned shares of EMC.
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