INTERNATIONAL BUSINESS MACHINES CORP. $192 (New York symbol IBM, Conservative Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 1.2 billion; Market cap: $230.4 billion; Price-to-sales ratio: 2.1; Dividend yield: 1.6%; TSINetwork Rating: Above Average; www.ibm.com) is the world’s oldest computer company (it began operating in 1911), with operations in over 170 countries.
The company continues to profit from its move away from mainframe computers and toward designing computer systems and managing them on behalf of its clients. The resulting long-term maintenance contracts give it more dependable revenue streams. IBM now gets 55% of its revenue from services.
The company continues to rapidly grow its software business. Right now, it is particularly focused on developing analytics software, which helps businesses and government agencies gather and analyze a wide variety of data. In addition, IBM makes software for applications ranging from traffic management to power grids and food production. Software now supplies 25% of IBM’s overall revenue.
The company still gets 18% of its revenue from its computer hardware business. The remaining 2% comes from its financing division.
IBM’s revenue rose 4.9%, from $98.8 billion in 2007 to $103.6 billion in 2008. Revenue fell 7.6% in 2009, to $95.8 billion, as the recession hurt demand for computers and consulting services. However, revenue rose 11.7%, to $106.9 billion, in 2011.
Recession couldn’t stop rising profits
Even with the uneven revenue, IBM’s earnings rose 56.6%, from $10.4 billion in 2007 to $16.3 billion in 2011. Earnings per share jumped 87.2%, from $7.18 in 2007 to $13.44 in 2011, on fewer shares outstanding.
IBM’s high research spending helps it maintain its dominance in the rapidly changing technology business. It spent $6.3 billion (or 5.9% of its revenue) on research in 2011, up 3.8% from $6.0 billion (or 6.0% of revenue) in 2010. Accounting rules force IBM to immediately write off these costs, so it’s more profitable than it appears.
In 2011, IBM received 6,180 patents in the U.S., up 4.8% from the prior year. This was also the 19th consecutive year that IBM received more patents than any other company. Licensing intellectual property generates around $1.1 billion in pre-tax annual income for IBM each year.
The company’s research spending is also helping make it a leader in the fast-growing field of cloud computing. That’s where data and software are kept on one or more centralized servers. Users connect to these servers over the Internet.
Cloud computing makes IBM’s clients more productive, cuts their costs and improves security. IBM’s revenue from cloud services more than tripled in 2011.
IBM’s strong reputation should give it an advantage over its cloud-computing competitors, because many businesses will be reluctant to trust sensitive data to less-familiar providers.
Dominating in high-growth markets
IBM’s reputation and new products will also help it expand in fast-growing markets, such as China, Russia, India and Brazil. In 2011, revenue from countries like these rose 16% (or 11% if you exclude the positive impact of foreign-exchange rates). These markets now account for 22% of IBM’s revenue. The company feels that will rise to 30% by 2015.
IBM is also expanding its expertise by purchasing other technology firms. That adds risk, but most of these are small companies that the company can easily integrate into its current businesses. IBM has earmarked $20 billion for acquisitions between 2010 and 2015.
The company’s strong balance sheet will easily support its expansion plans. Its $22.9 billion of long-term debt is a low 10% of its market cap. That debt is also just 1.1 times IBM’s 2011 cash flow of $21.4 billion. In addition, the company holds cash and investments of $11.9 billion, or $9.80 a share.
IBM signed $47 billion of new service contracts in 2011. Its service division’s order backlog is now $141 billion. That’s equal to 132% of IBM’s annual revenue.
Buffett stake attracts investor interest
IBM’s shares have gained 19% in the past year. That’s partly due to the November 2011 news that billionaire investor Warren Buffett now owns 5.4% of IBM through his Berkshire Hathaway Inc. (New York symbol BRK.A) holding company. This was Mr. Buffett’s first major investment in a technology company.
IBM trades at just 12.9 times the $14.85 a share that it expects to earn in 2012. The company also expects its earnings to rise to $20.00 a share by 2015. That gives it plenty of room to keep raising its dividend. The current annual rate of $3.00 a share yields 1.6%.
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