IBM, the Mild Blue Wonder


By Sam Jaffe For the first time in a long time, IBM (IBM) shareholders are feeling special again. Fifty years ago, they could take pride in owning the world's first tech stock. Twenty years ago, their company was the undisputed master of the information technology world at the dawn of the computer revolution. Since then, though, Big Blue has been stuck in neutral.

These days, while most tech companies are in hard reverse, neutral is a pretty good gear. On Apr. 19, the company reported its first-quarter earnings without any blowout numbers or bold strategic moves. The company came out with 98 cents per share in earnings, beating analysts' estimates of 89 cents, according to First Call. It didn't show rocket-fuel growth, just a comfortably pleasant 18% increase in earnings over the first quarter of 2000. Result: IBM's stock has jumped more than 10% between the day of the earnings report and May 1, when it closed at $118.51. All told, the stock is up 17% since the beginning of the year.

MANY WINNERS. Can IBM keep rolling along for the rest of the year? The answer, from the company and the analysts who follow it, is a resounding yes. Just as IBM has multiple lines of business, its current success has multiple reasons. And the company seems to be enjoying an open stretch of highway for as far as the eye can see.

The most important reason for IBM's good quarter is its diverse product lines. It has six divisions, five of which had better than expected growth. The only laggard was its PC business, which has historically lost money for Big Blue.

Of its other five divisions, the largest and most successful is Global Services. This includes consulting, outsourcing, and maintenance and produces more than 40% of IBM's $90 billion in revenue. One of the main reasons for Global Services' 18% jump in revenue was last year's atrocious first quarter. Because many corporations reined in their spending on services in order to deal with the Y2K bug in the first quarter of 2000, IBM's revenues took a huge hit after Jan. 1, 2000. "A lot of corporate business disappeared with Y2K, and it took a year for it to come back," says Stephen Dube, an analyst with Dresdner Kleinwort Wasserstein, who rates IBM a buy.

OLDIES BUT GOODIES. But now that Y2K is history, Global Services growth has no reason to dry up anytime soon. While most other services companies were chasing after the lucrative dot-com market in the last couple of years, IBM has invested heavily in becoming the e-business adviser of choice to large corporations. The irony is that the strategy is starting to pay off now that dot-com mania is over and money has ceased to flow into the sector. The behemoths of business still have computers to take care of. IBM boasts of an $87 billion backlog in services contracts over the next three years. That's one big cash cow guaranteed to produce milk.

Next, take the mainframe arena -- a declining business, but one that's essentially owned by IBM. Rather than divert profits from this mainstay unit to feed its younger activities, IBM has invested enormous amounts of research dollars into keeping mainframes competitive with decentralized networks for corporate-data needs. Its latest line of mainframes, introduced in the fourth quarter of 2000, has enjoyed two good quarters of sales, despite the fact that the devices garner frequent obituaries in the media. While we're probably at the peak of the sales cycle for IBM's new mainframe products, growth shouldn't slow tremendously over the next three quarters.

Then there's IBM's microelectronics division. Its success is an example of making your own good luck. Five years ago, IBM purposely exited the commodity microelectronics business to concentrate on producing goods only where it has a technological edge. Thanks to IBM's prodigious and successful R&D arm, its microelectronics operation actually produced more revenue in the first quarter than its mainframe division.

COPPER BECOMES GOLD. Much of that success is owed to a significant breakthrough three years ago, when IBM researchers discovered how to use copper instead of aluminum for the wiring in semiconductor chips. Almost every chipmaker is now making plans to switch to copper. Who better to buy parts and materials from than the inventor of the process?

Even more impressive is the microelectronics division's success at avoiding the inventory overload that almost every other hardware manufacturer is enduring. Much of that is because the company was barely able to meet demand last summer, when most companies started piling up unsold product.

As a result, no warehouse shelves are waiting to be emptied before the production lines start again. Since IBM doesn't have any inventory to clear, and since demand is growing for its copper technology, don't expect microelectronics shipments to decline anytime this year.

STEADY AS SHE GOES. The only weakness in an otherwise strong quarter was the PC division, which lost money. But don't believe the rumors that IBM is about to jettison the business. "Even though the PC isn't driving the IT industry anymore, it's still a very important business for IBM," says Wit Soundview analyst Gary Helmig, who rates the stock a strong buy. "It's a foot in the door for other, higher-margin products like software and services."

IBM's slow-growth steamroller shouldn't pause any time soon. All of the pieces of the pie that made the first quarter a success should remain in place for the rest of the year. CEO Louis Gerstner agrees. During the conference call announcing the earnings, Gerstner said he's "optimistic about the next three quarters." Yes, he warned, "IBM isn't immune to an economic slowdown," adding that a further deterioration in the economy will surely impact revenues. Nevertheless, the company is like a tank in a hurricane: While competitors try desperately to cope with high winds and slippery roads, Big Blue keeps rolling right along. Jaffe writes about the markets for BusinessWeek Online in our daily Street Wise column

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