INTERNATIONAL BUSINESS MACHINES CORP. $194(New York symbol IBM, Conservative Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 1.0 billion; Market cap: $194.0 billion; Price-to-sales ratio: 2.1; Dividend yield: 2.3%; TSINetwork Rating: Above Average; www.ibm.com) started up in 1911 making machines that processed U.S. census data, as well as other industrial equipment such as time clocks and scales.
The company now gets 55% of its revenue by designing computer systems and managing them for business and government clients. It typically does this under long-term contracts, which cuts its risk.
In the past few years, IBM has aggressively expanded its software business. It’s particularly interested in analytics software, which helps clients gather and analyze a wide variety of data. Software now supplies 27% of IBM’s revenue.
The company’s computer hardware business, which accounts for 14% of its revenue, continues to shrink. That’s because it is selling its less-profitable operations to focus on mainframe computers.
For example, IBM recently agreed to sell its lowend server business to China’s Lenovo Group. The Chinese government has already approved the deal, but it’s unclear if U.S. regulators will do likewise. That’s mainly because U.S. government and military agencies use these servers, and selling these operations to a Chinese company could compromise sensitive data.
IBM still expects to complete the sale by the end of 2014. If it does, it will receive $2 billion in cash and $300 million in Lenovo shares.
Faster chips would spur software sales
The company wants to sell all or part of its computer chip manufacturing business. However, it will keep developing high-end chips, which should help improve the performance of its analytics software. It has earmarked $3 billion over the next five years to develop new ways to make chips smaller and faster, including using materials other than silicon.
The remaining 4% of IBM’s revenue comes from providing loans to buyers of its mainframes.
IBM’s revenue rose 11.7%, from $95.8 billion in 2009 to a record $106.9 billion in 2011. However, revenue fell to $104.5 billion in 2012 and to $99.8 billion in 2013. That’s partly because IBM sold its point-of-sale business, which makes cash registers and other equipment for retailers. Unfavourable currency rates also hurt its revenue growth.
The company’s earnings rose 23.7%, from $13.4 billion in 2009 to $16.6 billion in 2012. Per-share earnings jumped 49.3%, from $10.01 to $14.37, on fewer shares outstanding. Earnings dipped to $16.5 billion in 2013, but per-share earnings rose to $14.94.
IBM continues to invest in research, which helps it compete in the rapidly changing technology business. It spent $6.2 billion (or 6.2% of its revenue) on research in 2013, down 1.2% from $6.3 billion (or 6.0% of revenue) in 2012.
Thanks to this spending, IBM received 6,809 patents in the U.S. in 2013, up 5.1% from 6,478 in 2012. This was also the 21st consecutive year that IBM received more patents than any other firm, and the most ever awarded to one company in a single year. Licensing intellectual property generated $822 million in pretax income for IBM in 2013.
Acquisitions play a key role
The company bolsters its research by acquiring smaller firms with attractive technologies. In 2013, it spent $3.1 billion buying 10 companies.
Its biggest acquisition was its $2.0-billion purchase of SoftLayer Technologies, a Texas firm that sells online data storage and related services to 21,000 businesses.
SoftLayer will help IBM profit from rising demand for cloud computing. The company expects its cloud computing revenue to rise from $4.4 billion in 2013 to $7.0 billion by 2015.
IBM’s recent alliance with Apple should also spur sales of its cloud computing services and analytics software. Under this deal, IBM will develop businessrelated apps for the iPhone and iPad. It will also provide companies that use its mainframes and software with on-site support for Apple products.
Watson is ready for prime time
The company is optimistic about Watson, the supercomputer that beat human contestants on the TV quiz show Jeopardy. IBM feels Watson is ready to help its clients with their complex computing needs, and plans to spend $1 billion to develop new commercial uses for this machine. Watson could add $10 billion to IBM’s annual revenue within 10 years.
IBM’s balance sheet remains strong. Its $34.0 billion of long-term debt (as of June 30, 2014) is a moderate 18% of its market cap. It also holds cash and investments of $9.7 billion, or $9.60 a share.
The company is also cutting 3% of its workforce, which should help boost its earnings to $18.00 a share in 2014. The stock trades at just 10.8 times that estimate. IBM still aims to raise its earnings to $20.00 a share by 2015. The $4.40 dividend yields 2.3%.
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