IBM proves that big doesnt mean slow


  Recent Price
  P/E Ratio
  Shares (millions)
  Long-Term Debt as % of Capital
  52-Week Price Range
$130.93 - $97.04

Acquisitions and cost cuts have accounted for most of IBM’s ($123; NYSE: IBM) growth in recent years. But over the last 12 months, the picture changed. Strong operating momentum is now propelling genuine operational growth despite economic weakness in the U.S.

For more than a decade, IBM lived up to its reputation as a slow-growing, stodgy company. In the 10 years ended 2006, sales increased at an annualized rate of less than 2%, and the company lost both market share and influence. However, sales growth has accelerated in each of the last three quarters, and per-share profits have risen at least 23% in each period. Consensus estimates, trending upward over the last month, project per-share-profit growth of 24% in 2008 and 11% in 2009. IBM is a Focus List Buy and a Long-Term Buy.

Strength through diversity
A broad business mix has helped the company keep growing during the economic slowdown. IBM may still be best known for its hardware, but the company’s strength over the last year has stemmed from the services and software businesses, which tend to be less economically sensitive than hardware.

Hardware accounted for about 18% of sales in the six months ended June, while services represented 58% and software generated 20%. Financing operations brought in most of the last 4%. While the current economic climate has pinched the consumer, companies are still investing heavily in new technology. IBM’s products and services help customers improve efficiency, productivity, and security, which in turn can reduce costs.

In the six months ended June, IBM’s revenue rose 12%, while per-share-profits jumped 34%. Revenue from services increased 17% in the six-month period. In the June quarter, IBM signed $14.7 billion in service contracts, up 12%, increasing the services backlog to $117 billion, nearly twice annual services revenue. Software revenue jumped 15% in the six months ended June. Services and software growth more than offset a 2% decline in revenue from the systems and technology unit, which produces servers and other hardware.

Foreign exposure
IBM is also benefiting from its strong presence overseas, particularly in emerging markets. Foreign sales accounted for 63% of 2007 revenue, a percentage likely to increase in coming years. Emerging markets — such as Brazil, Russia, India, and China, which combined to post a 31% sales gain in the June quarter — represent a strong growth opportunity for IBM. The company is investing heavily in the four huge countries, as well as in Eastern Europe and the Middle East.

Management expressed concern about economic weakness in some of the world’s largest developed markets, including the U.S., but that worry has been factored into growth expectations. IBM targets per-share profits of $10 to $11 in 2010, representing annualized growth of 12% to 16% from 2007 levels.

Given its growth prospects, the stock seems attractively valued at 13 times estimated year-ahead earnings, below the five-year average forward P/E ratio of 15. An annual report for International Business Machines Corp. is available at 1 New Orchard Road, Armonk, NY 10504; (914) 499-1900;

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