Markets & Finance

Marcial on IBM: A Bullish Case for Big Blue


IBM's results-oriented strategy—most recently demonstrated by the acquisition of software outfit Exeros—could take the stock higher

Technology stocks are back, and IBM (IBM) is among those spearheading the stock market's recent advance. After tumbling to a 52-week low of 69.50 a share last Nov. 20, IBM has recovered nicely, closing at 105 on May 5.

True, that is still below its 52-week closing high of 130.93 reached on July 24, 2008. But some close IBM watchers believe the stock is well on its way to surpassing that peak in the next 12 months. On May 5, Standard & Poor's analyst Thomas W. Smith raised his 12-month price target to 139 from 130 after IBM announced it was buying Exeros, a small, privately held software outfit. (S&P, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP).)

Smith says the acquisition will add "capability to IBM's initiatives aimed at helping customers make sense out of their business data," and use the information for "competitive and strategic purposes." He adds that by making warehoused data more valuable to clients, IBM will spur interest in both its consulting services and other product lines.

As a result, Smith, who rates IBM a strong buy, sees increased value in the company's strategy and figures it deserves a higher price target in part based on its price-earnings ratio: The stock currently trades at 14 times his 2009 earnings estimate of $9.25 a share. His new stock price target of 139 puts IBM's p-e at 15, which, he notes, may be even modest, based on IBM's historical p-e multiple range of 15 to 20. The last time IBM's stock hit 139 was in 1999, when its p-e ratio was 34. For 2010, Smith forecasts IBM earning $10.20 a share.

Fast Track to Profits

IBM, which S&P describes as the world's largest technology company, provides a diversified line of computer hardware, application and systems software, and related services. The purchase of Exeros didn't attract much attention on the Street, but it demonstrates that after the failed attempt to acquire Sun Microsystems (JAVA), which would have been the largest acquisition in its history, "IBM has resumed its traditional strategy of focusing on small, technology-focused software purchases," says Allan Krans, senior analyst at Technology Business Research.

Selectively buying small companies allows IBM to expand distribution and revenues rapidly following the acquisition, and quickly achieve profitability, generating a positive return on the purchase price, says Krans. He estimates the purchase price for Exeros, which hasn't been disclosed, to be about $50 million.

IBM says Exeros would further strengthen Big Blue's "information agenda," helping companies turn data into strategic assets and provide new capabilities for its Business Analytics Optimization consulting service. Exeros' technology, according to the company, automatically uncovers hidden relationships between databases, helping users make sense of disparate data sources much faster than otherwise possible. This capability reduces the cost of data-intensive projects, adds IBM, such as data warehousing and master data management.

In sum, IBM's clients will be able to identify new market trends and predict business outcomes with increased certainty. One example is what airlines could do using Exeros software: They can consolidate customer award information from multiple databases containing millions of client records down to a single master record. The system would save the airlines time and money in gaining insights into their customers.

Higher Margins Ahead?

S&P's Smith expects IBM's revenues, which jumped to $103.6 billion in 2008, to decline by about 5% in 2009 because of slower global economic growth, plus negative currency effects. But he sees revenue growth recovering in 2010 by 5%, based on a projected economic recovery worldwide. He also expects robust growth in IBM's software segment, reflecting the impact of past acquisitions, including Cognos, Platform Solutions, and ILOG.

Smith also forecasts that gross margins will expand to 44.7% in 2009 and to 44.9% in 2010, from 2008's 44.1%, partly from cost reductions and an improved sales mix, in which higher-margin products and services account for a greater percentage of the total.

The rise of earnings per share "tells the whole story abut how IBM was able to expand its bottom line in spite of slower growth in revenues in the first quarter of 2009," says analyst Amitabh Goel of First Global Markets, who rates the stock a moderate outperform. He says IBM appears to be a "safe bet" amid the global uncertainty.

Analyst Daniello Natoli of research outfit EVA Dimensions rates IBM a buy as it has strongly outperformed the market, and "represents very high potential to create economic value for shareholders." EVA Dimensions bases its analysis on fundamentals, such as sales growth, profit margin, stock price volatility, free cash flow, and financial leverage.

Some of the biggest institutional investors lead the long line of IBM shareholders, including State Street (STT), Bank of New York Mellon (BK), Barclays Global Investors (BCS), and Vanguard Group. And Wall Street analysts remain upbeat on Big Blue, with 71% of 27 analysts who follow the company rating the stock a buy. That's one data point that should capture the attention of investors looking for a high-quality tech holding.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.


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