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William Schaff
William Schaff
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Taking Stock: IBM's Numbers Look Better Than Most

IBM generally leads the earnings parade each quarter. The nice thing about listening to IBM's conference call is that the company's business encompasses almost every sector of technology, including services, software, and hardware. IBM's results usually give a very strong indication of what other companies are likely to report. But this quarter may be different.

IBM clearly is doing better financially than some of its technology brethren. It believes it's gaining market share and that these market-share gains translate into increased revenue and profitability.

IBM reported first-quarter revenue of $20.1 billion, an increase of 11% year over year. Of that, $10.2 billion, or 51% of total revenue, came from the Global Services unit, which includes the recently acquired PWC Consulting. Global Services revenue grew 24% year over year, but most of that was attributable to the consolidation of PWC Consulting. Hardware revenue was $5.8 billion, or 29% of total revenue; software revenue was $3.1 billion, or 15%. Global financing and enterprise investment made up the balance, about $1.0 billion. Hardware sales declined 1% year over year, while software revenue grew 8%. Overall gross margin came in at 36%, almost flat year over year despite a 1.1% decline in Global Services' gross margin to 24.9%. Global Services' backlog at quarter's end was estimated to be $113 billion, including first-quarter signings of $12 billion of new business. The strength of the pipeline continues to be in technology and process outsourcing revenue, which grew 63% year over year. This accounts for roughly 30% of total services revenue. Strategic outsourcing remains the largest portion of services revenue, at about 40%. Integrated technology services makes up the balance. All services revenue grew in the double digits.

The strength in hardware was primarily in midrange products and servers. Personal-systems group revenue was $2.4 billion, down 5% year over year. Technology group revenue was $663 million, down 14%, but the segment's loss declined to a modest $11 million despite a steep decline of $128 million in revenue from last year.

Software revenue was $3.1 billion but included a little over a month of impact from the $2.1 billion acquisition of Rational Software. That acquisition extends IBM's presence in middleware software and related tools. IBM claims it's gaining share in middleware and database management. This point is contested by competitors, who say IBM accounts for sales differently. Regardless, IBM will be a strong competitor in enterprise software, and acquisitions in this area are likely to continue.

At the current price of about $80 per share, IBM seems fairly valued. Wall Street's consensus forecast is for 2003 earnings per share of $4.32. As the company has agreed with the full-year consensus estimate, I still think most of it will be earned in the second half of the year. After all, it earned only 79 cents per share in the first quarter.

The stock is neither grossly overvalued nor cheap. The current 2003 price-to-earnings multiple is 18.2. For a company that's likely to grow 8% to 10% in earnings per share over time, this multiple seems generous but in line with the broader equity market. Yes, certain companies get a higher share-price premium over fair value for business stability and liquidity, and IBM clearly qualifies on both counts. Just don't pay too much of a premium.

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