IBM earnings beat Street but business-spending worries haunt shares
Even worse, IBM CFO Mark Loughridge used the "s" word -- stabilize -- to describe the enterprise technology markets. He might as well have used that other s-word. Investors, who had bid up IBM shares by $10 in the past two weeks from $117 to $127, wanted more than stabilization from IBM.
Some broader trends may also have weighed against IBM as it tries to expand its lucrative software business, an area Loughridge highlighted as having big margin expansion potential. Virtualization, which allows companies to partition powerful computer servers into a number of virtual computers, is acting as a long-term drag on both the hardware and software licensing market. In hardware, virtualization is picking up steam as it hammers server makers who are used to selling customers more boxes that they know will never hit capacity.
In software, virtualization has allowed for more software-as-a-service offerings to large businesses. While that's great for IBM's services businesses -- software outsourcing is one of its growth centers -- it's lousy for IBM's sales of software licenses, a far more profitable business offering.
IBM highlighted the number of big outsourcing contracts it has nailed down. That's good as long as the customers don't decide to walk, in which case recovery from such a big busted engagement could be costly and time consuming. In fact, the state of Indiana canceled a $1.3 billion services contract with IBM a day after the earnings release. The full contract would have been spread over a number of years, so IBM will not take an immediate revenue hit. But one or two more losses could easily turn momentum around and slow IBM's revenue growth.
Despite these caveats, by almost every metric aside from year-over-year revenue growth, IBM looked sharp. Company-wide gross margins expanded by almost two points and earnings per share leaped by 18 percent year-over-year to $2.40. The company is growing more quickly in the developing world, a good sign as that's where the big economic growth remains in the global economy. Big Blue generated an impressive $3.4 billion in free cash flow, up $1.3 billion from the previous year. Company CEO Sam Palmisano upped earnings guidance to at least $9.85 per share for 2009, a 15 cents per share bump from previous numbers.
IBM claims it posted single-digit market share gains in both hardware and software against competitors such as Sun (JAVA), Oracle (ORCL), Hewlett-Packard (HPQ), and Microsoft (MSFT). Big Blue also improved margins for its services businesses and plans to continue to improve them through $3.5 billion in cost savings expected to be realized over the entirety of 2009. With over $11 billion in cash and the M&A market starting to pop again (witness Google's indication that it wants to start acquiring companies again), IBM indicated that it will probably make more acquisitions.
Add it all up and this is a glass half-full or glass half-empty story. IBM is, as my colleague Peter Cohan wrote, IBM is among the best managed large capitalization companies in the world. However, its shares are no longer cheap and an L-shaped economic recovery could make investors even more wary of profit gains coming primarily from cost cutting.