The earnings from tech/IT giant IBM (NYSE:IBM) should give tech investors a little respite from the fear cycle going into calendar fourth quarter earnings - at least until the next widely followed company flames out with results and/or guidance. Not only did IBM do quite well with revenue and margin performance, the company's guidance for 2013 was both solid and not particularly back end-loaded. These shares aren't particularly cheap, but IBM remains a reasonable one-stop shop for investors seeking tech exposure.
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Solid All-Around Performance
While I would not characterize IBM's performance in its fourth quarter as a blowout, it was a good report in a market that needed one.
Revenue fell 1% as reported, was flat on a constant currency basis, and rose 1% excluding a divestiture - squeaking out a couple hundred million dollars ahead of expectations. The company's huge services operations saw a 2% year-over-year decline in revenue, while hardware declined 1%. Software revenue rose 3% from last year's level. It's worth noting, however, that all segments were up sequentially - from 4% in services to 48% in hardware.
IBM's margins came in looking pretty good at 48.1% for 2012. Gross margin improved more than two points from last year, helped by strong mainframe sales and a heavier mix of software. All segments saw better gross margins, with hardware up a little less than four points and software up nearly one point (to more than 90%). Operating income rose 10% from last year, with better than two and a half points of operating margin improvement.
Not Quite "All Clear" for Hardware, but no Cause for Alarm
A lot of analysts have been playing whack-a-mole with leading tech hardware names in the weeks leading to this earnings cycle. IBM's results may suggest that some of that fear was overdone, but it's still not an easy market out there.
IBM's mainframe sales jumped 56% on a new product cycle. The company's x86 server business saw revenue decline about 3%, with some share loss, but the market still looks weak for Hewlett-Packard (NYSE:HPQ) and Dell (Nasdaq:DELL). Power system sales were down even worse, minus 19%, as the company gears up for new product launches. Even with that result, management believes IBM held its own with companies such as HP and Oracle (Nasdaq:ORCL). Storage was down another 5%, and the company likely lost share.
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Good Ongoing Growth in Software
IBM continues to log good performance in its software business. Overall software revenue was up about 3%, with key branded middleware up 5% (with Lotus up 9% and WebSphere up 11%). IBM also reported that full-year growth for analytics reached the low teens (13%), with cloud revenue up 80%.
Service - Getting More Selective
IBM's service business could be seen by some as disappointing. Revenue declined 2% overall, which looks like a small beat relative to expectations. Signings were down 12%, though, and more than 10% below sell-side expectations. I'm not sure this is such a bad thing, however, as it looks like IBM is getting increasingly selective with the business it takes and has been turning down business that doesn't meet its margin targets. That will create some opportunities for rivals like Infosys (NYSE:INFY) and Cognizant (Nasdaq:CTSH) to pick up more business, but may leave them vulnerable to the "winner's curse."
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The Bottom Line
IBM's somewhat defensive positioning could leave it vulnerable to underperforming higher-beta tech names if this sector really gets rolling again this year. I'm still curious to see where IBM may go next with its hardware business. The company has been spending capital on building up its software business through deals, but it hasn't been quite as active on the hardware side. I wouldn't be stunned to see a bid for a company such as NetApp (Nasdaq:NTAP), Fusion-io (NYSE:FIO), Fortinet (Nasdaq:FTNT) or Palo Alto (NYSE:PANW), as storage and security look like areas where IBM could stand to get better.
I'm not enamored with IBM's stock today. Even assuming that the company grows faster in its future than its recent past (a revenue compound annual growth rate (CAGR) of nearly 3%) and does so more profitably (leading to a free cash flow CAGR of more than 5%), the shares seem to be worth around $200 today. Holding fairly valued IBM shares is hardly a terrible idea, but there are better ideas today for investors looking to take new positions in the tech sector.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.