Hot Stocks: IBM's Diverse Business and Global Presence Should Boost First Quarter Earnings

By Mike Caggeso
Associate Editor
Money Morning

India’s information technology industry is one of the largest operations in the world – employing millions of engineers, technicians and customer service specialists who serve the world’s second-largest population.

The industry has enabled socio-economic development, enhanced economic growth and productivity, reduced poverty, and improved standards of living across the board. It’s even helped develop nuclear power in India.

And the company standing at the top of India’s IT mountain is not Infosys Technologies Ltd (INFY) or Tata Consultancy Services. And it’s certainly not Satyam Computer Services (ADR: SAY). 

It’s Armonk, N.Y.-based International Business Machines Corp. (IBM).

“They’ve beaten their competition relatively handily,” Kaufman Bros.’s Karl Keirstead told Bloomberg, who pointed to IBM’s brand name and experience as draws for potential clients. “There’s a cachet in using IBM.”

IBM’s model is the anti-model. Whichever country the company is working in, it has a game plan exclusively catered to it. It encompasses not only the determination of the customer needs, but also the provision of every aspect of the required technology solutions – including recurring maintenance, updating and even financing.

And financing is crucial these days. IBM’s long history in the world’s markets has given the company a recognition and credibility abroad, helping to mitigate competitive threats from unproven newcomers.

Its presence in India will yield dividends as India’s economy emerges from the global financial crisis.

IBM leaders have shrewdly increased the company’s investments in the fastest growth areas of the world, increasing its unparalleled geographic diversification as it keeps emphasizing its higher-value businesses – especially software, highly profitable middleware and services.

At the beginning of 2009, 71% of IBM’s nearly 400,000 employees are working overseas – a 65% increase from two years prior.

In fact, IBM incorporates the words “global” or “world” in nearly every sentence of the business strategy outlined in its annual earnings report of 2008.

“The Internet has enabled communication and collaboration across the world and brought with it a new computing model premised on continuous global connection. In that landscape, companies can distribute work and technology anywhere in the world,” the report said.

It continues: “At the same time, the current economic crisis increases the pressure on both businesses and governments around the world to adapt…. Given these opportunities and economic challenges, IBM is working with its clients to develop new business designs and technical architectures that allow their businesses the flexibility required to compete in this new landscape.”

IBM Boosts Profits with Business Overhaul

In addition to global diversification, IBM has also successfully employed a versatile and aggressive business model. Between 2000 and 2008, IBM acquired more than 100 companies and poured more than $50 billion into research and development.

In 2000, the distribution of IBM’s business model was: Hardware (24%), software (25%), financing (10%) and services (40%). 

But by the end of last year, the model had evolved to: Hardware (9%), software (40%), financing (9%) and services (42%).

The result was a 130% increase in annual earnings per share (EPS) on more than 22% annual revenue growth in that span.

For 2008 – by far one of the worst years for companies around the world – IBM posted an 18.4% increase in net income and 23.9% increase in earnings per share.

And IBM blew away analysts’ estimates with a fourth-quarter net income of  $4.4 billion, or $3.38 a share – a 12% increase from 2007. Analysts had expected IBM to earn only $3.03 per share.

What’s more is that the first quarter of 2009 is shaping up to be much better.

IBM said it expects a $9.20 EPS in fiscal 2009, up from the $8.93 it posted in 2008. It’s also forecasting an EPS in the range of $10 and $11 in 2010.

But more than anything else right now, investors want to first see the company’s first-quarter results, due Monday.

IBM’s Eventful First Quarter

IBM’s biggest news came in March, when the company made a $6.5 billion, or about $10 per share, bid for Sun Mircosystems Inc. (JAVA). IBM subsequently lowered its offer to $9 per share and talks fell apart. 

According to a recent report by CNBC, Sun has attempted to restart negotiations, but IBM is wary of the government scrutiny that may result. A combined IBM-Sun business would dominate the server market with a near 50% share – something that could set anti-trust alarm bells ringing.

However, if IBM did move ahead with the Sun acquisition, the company would not only build on its hardware business and take control in the server market, it would further expand its software portfolio, which is the company’s most profitable business.

Regardless of whether or not it reaches a deal with Sun IBM has plenty of business to build on.

Big Blue is teaming up with tech giants to build 28-nanometer (nm) chips, a little more than a generation ahead of 45nm technologies used by industry leaders Intel Corp. (INTC) and Advanced Micro Devices (AMD), CNET reported.

It also recently inked a seven-year, $372 million deal to manage IT infrastructure of Canada’s National Financial Group (NA). That came three days after IBM announced a similar deal with of one India’s largest banks, Kurmanchal Nagar Sahakari Bank, which is planning to double the number of its branches in the next two years. 

Finally, last week, IBM won an eight-year, $873 million contract with the state of Georgia to provide mainframes, servers, printers, service desk, end-user computing and disaster recovery.

Elliott Gue, editor of Personal Finance newsletter, wrote that IBM’s IT services are a steady revenue stream, and are a product of its long-established relationships with the world’s biggest companies.

And now – with spending tightening around the world – is the time they especially turn to IBM. 

“Many of IBM's key software and service offerings are designed to cut costs for companies and improve the efficiency of their IT infrastructure,” Gue wrote. “And during downturns, companies are always looking for ways to cut costs.”

Analysts polled by Thomson Reuters forecast first-quarter earnings of $1.65 a share on revenue of $22.6 billion. IBM earned $1.65 a share on revenue of $24.5 billion a year earlier.

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