Strong market share in a variety of hardware, software, and IT service markets makes IBM (NYSE:IBM) a great company, but it doesn't immunize investors against the risks of holding an overpriced stock. To that end, while I've liked the company for some time, I've also thought the shares were too pricey. With the stock down about 5% over the past quarter (and underperforming the S&P 500 by about 14%), though, IBM shares have gotten closer to a potential buy point.

Okay Second Quarter Results, But Quality May Be A Talking Point
IBM missed the top-line target for the second quarter, reporting that revenue fell 3% (or 1% on a constant currency basis). Not unlike Accenture (NYSE:ACN), IBM saw weakness in its large service operations, with revenue down 4%. Hardware remains very weak, with revenue down 12% (though up 21% on a sequential basis), but software was up 4%, with 8% organic constant currency growth in middleware.

IBM's margins were once again mixed. Gross margin improved more than a point from the year-ago level, but operating income declined 15% and the margin declined about two and a half points. It's well worth noting that 12 cents of the company's 13-cent beat was generated from a lower tax rate. It's also worth noting that IBM has changed how it calculates its non-GAAP EPS numbers – although this doesn't change much of anything from a cash flow perspective, it could create some worries about the clarity/quality of IBM's reporting

SEE: A Look At Corporate Profit Margins

How Did IBM Do So Well In Software?
The biggest surprise to me in this quarter was the strength of IBM's middleware business. Websphere revenue was up 10% this quarter, which was much, much stronger than the results reported a little while ago by Oracle (Nasdaq:ORCL) and TIBCO (Nasdaq:TIBX). While I'll grant that maybe conditions are getting better again in the market, it's hard for me to think that IBM isn't gaining share in the middleware market from Oracle, TIBCO, and Software AG (Nasdaq:STWRY). Likewise, the company's information management, Tivoli, and Rational businesses seem to be doing very well against the likes of Oracle, Microsoft (Nasdaq:MSFT), CA (NYSE:CA), and Hewlett-Packard (NYSE:HPQ).

Hardware Still Struggling
IBM's hardware results aren't encouraging for investors hoping for a similar turnaround in this segment of the tech space. Mainframe sales were up 11%, but server sales were weak again (both System p and System x sales were down double-digits), and IBM continues to lose share in its traditional storage hardware operations.

Services Still Adjusting
While IBM's results in the services segments weren't as strong as those recently reported by Infosys (Nasdaq:INFY), companies like Accenture and Hewlett-Packard are probably the better comps. In any case, the 20% year-on-year growth in signings was a positive sign that companies are getting a little more willing to commit to projects beyond 2013. At the same time, investors shouldn't overlook that IBM is still going through some adjustments and restructuring designed to unwind less profitable business, so I don't necessarily believe that this quarter's results are a completely clear look at the health of the business.

The Bottom Line
With as much as $6 billion left to spend on M&A over the next couple of years, IBM still has capital to put to work in expanding its business operations. Moreover, the strength in software suggests that IBM is still pretty competitive on its own merits and has a solid vision for how the enterprise IT market is evolving.

SEE: Technology Sector Funds

I'm still looking for modest growth from IBM (3% revenue growth, 5% free cash flow growth), as I believe that a company of this size is going to be find it challenging to post significantly above-market growth rates for extended periods of time. In any case, those growth numbers suggest a fair value of over $190, which puts these shares as close to value territory as they have been in some time.
Tickers in this Article: IBM, ORCL, HPQ, ACN

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