Tuesday, July 19, 2005

IBM Delivers The Goods?


IBM delivered the goods with strong 2Q operating results…

Thus begins the Merrill Lynch message on last night’s second quarter earnings report from Big Blue, in which net income grew all of 5.4%

Revenue growth ex-PCs was 6%...

Actually, 2% of it came from currency, so the real revenue growth was 4%, but who am I to correct Merrill Lynch?

With operating EPS of $1.12 versus our $1.05 estimate…

For the record, this so-called “operating EPS” excludes a $1.7 billion restructuring charge related to elimination of 14,500 employees, which amounts to $1.06 per share. Is it really a heroic feat to “beat the number” by seven pennies, with one hundred and six brand new non-cash pennies floating around the balance sheet?

Of course, an IBM quarter isn’t really a quarter without a restructuring charge, so the appearance of $1.7 billion in charges was so unremarkable that Wall Street’s Finest barely remarked on it.

This is, after all, the same IBM which has taken $4.6 billion in “non-operating” charges in the last four years. So good is IBM at managing “non-operating” charges that, in one of the amazing accounting coincidences of all-time, this quarter’s $1.7 billion restructuring charge was almost exactly offset by $1.9 billion in non-recurring gains from the recent settlement with Microsoft and the sale of the PC business.

Who knows what future earnings potential lurks in $1.7 billion worth of “restructuring charge”?

But, getting on with the news that excited Wall Street the most:

Services bookings and profits sharply improved. Services bookings soared to $14.6 billion…

“Soared” is, in fact, an appropriate verb, since the services bookings were 45% higher than the year ago quarter. Unfortunately, bookings are still down 12% for the trailing twelve months.

Furthermore, the question arises as to how exactly did this company magically turn around a multi-billion dollar, people-intensive business in a mere 90 days? Accenture provided the answer when, on that company’s recent conference call, management spoke of IBM’s “aggressive behavior” in pricing new deals by saying “at any point in time” people act in such a way that “you scratch your head…”

And low and behold, the aggressive behavior may have consequences down the road:

[IBM] management also indicated that margins would be compressed in early years for some new contracts, as IBM is giving clients more savings upfront (i.e. lower pricing) with the intent of making up for this on the back end through better efficiencies down the road.


Nevertheless, despite the aggressive pricing,

… pretax margin rose with better consultant utilization.

When 14,500 people leave a company, the utilization of the remaining employees does tend to rise.

All in all, it was a typical IBM recovery from a weak quarter: mediocre sales growth, middle-of-the-S&P-pack net income growth and per-share earnings boosted by share buybacks, plus a big fat restructuring charge to help future earnings…and it was enough to bring a sigh of relief from Wall Street’s Finest.

IBM’s CEO said in the press release that IBM had “returned to form” this quarter after the first quarter’s poorly-received results.

With a $1.7 billion cookie jar—er, restructuring charge—safely tucked into the balance sheet; a rejuvenated backlog in the services sector purchased (according to even its most ardent fans) with up-front discounts not to be reckoned with for years to come; yet another lagging business (personal computers) abandoned to better competitors, and Wall Street’s Finest back on the sidelines, pom-poms waving, Big Blue is indeed “back in form.”


Jeff Matthews
I Am Not Making This Up



The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

3 comments:

Ed said...

Jeff Matthews rocks!!!

BelowTheCrowd said...

As a sometimes IT professional I can say that I've seen this all before.

"IBM is giving clients more savings upfront (i.e. lower pricing) with the intent of making up for this on the back end through better efficiencies down the road."

Yeah. In other words, you'll do everything possible to underbid, then come up with every reason under the sun to explain the late deliverables, shoddy quality, nonexistant staff and generally lousy experience of working with you, proving once again that you get what you pay for and ensuring that you'll join the long and growing list of firms we will never do business with again.

-btc

BelowTheCrowd said...

And as a further note, often the justification given by desperate consultants giving lowball pricing is that they hope to make it up on future revenue from the "relationship" that they're building from the first deal.

There may have been a time that such arguments would not have been laughed out of the room, but it's not today. Today you fight for every deal and the "long term relationship" lasts no longer than the end of the contract. It's a cruel world in which you can't do much to improve your chances of being selected next time, but can do an awful lot to ensure that you won't even get the RFP.

Strangely, Wall Street hasn't figured this out, as it's exactly the same kind of dynamic that has plagued investment banking "relationships" in the past decade.

-btc