INTERNATIONAL BUSINESS MACHINES CORP. $86 (New York symbol IBM; Conservative Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 1.3 billion; Market cap: $111.8 billion; WSSF Rating; Above average) is the world’s largest computer company, with operations in over 170 countries. It specializes in large mainframe computers for governments and corporations. The company now gets over 50% of its revenue from its service division. Steady revenue streams from long-term contracts for designing and maintaining computer systems cuts IBM’s risk. IBM continues to expand its software operations, mostly through acquisitions. The company is now the world’s second-largest software maker after Microsoft Corp. Owning its own software business makes it easier for IBM to design and build customized computer systems for its clients. As well, using its own software lets IBM avoid paying licensing fees to other software makers.
New computers use less power
IBM also continues to develop advanced computer technology, particularly chips. The company’s new chips can perform more functions than its older models, while using less power. This technology gives IBM’s mainframes and other computers an advantage, particularly as increasingly cost-conscious business customers look for ways to cut their electricity consumption. IBM’s revenue grew 10.8%, from $89.1 billion in 2003 to $98.8 billion in 2007. However, earnings jumped 36.8%, from $7.6 billion in 2003 to $10.4 billion in 2007. IBM is an aggressive buyer of its own shares. Consequently, earnings per share grew 65.4%, from $4.34 in 2003 to $7.18 in 2007. In the three months ended September 30, 2008, IBM’s earnings rose 19.6%, to $2.8 billion from $2.4 billion a year earlier. Earnings per share grew 22.0%, to $2.05 from $1.68. Revenue rose 4.9%, to $25.3 billion from $24.1 billion. If you exclude the positive benefits from foreign currency exchange rates, revenues rose 1.7%. Revenue from services grew 13.6% in the latest quarter. However, new contract signings fell 4%, to $12.7 billion, due to the slowing economy. The order backlog at IBM’s service division is now $114 billion. That’s 5% more than the entire company’s annual revenue.
Still the top U.S. patent winner
IBM continues to spend about 6% of its revenue on research. This hurts its earnings, but new products from this research could continue to fuel its growth in the highly competitive computer industry. The company has won more U.S. patents than any other company for the past 15 years. IBM’s patent portfolio generates revenue of roughly $1 billion a year. IBM’s strong balance sheet should continue to let it expand research spending. Long-term debt of $18.2 billion is just 10% more than its annual cash flow of roughly $16 billion. IBM also holds cash of $9.8 billion or $7.26 a share. The company will probably use some of that cash to acquire smaller technology companies, perhaps at bargain prices. The company also stands to gain from new government infrastructure spending, in the U.S. and other countries. These plans include major investments in expanding high-speed Internet networks. Right now, high-speed access is available mainly in big cities. That’s because phone and cable companies would lose money by expanding coverage to sparsely populated rural areas. IBM is now working on a system that would use existing electrical power lines to transmit high-speed data signals.
Power-line Internet has big potential
The company recently received a $9.6 million contract to install and manage this technology in seven states. That’s small compared with IBM’s total revenue. However, the potential market for this system is huge — there are currently 30 million U.S. households without high-speed access. If successful, IBM could also sell this technology to overseas power companies. The stock is down 34% from its peak of $131 in July, 2008. Investors worry that businesses will cut investments in new computers as the economy weakens. The collapse of several banks and brokerage firms could also hurt IBM’s sales growth. As well, IBM gets two-thirds of its revenue from customers outside of the U.S. A rising U.S. dollar would hurt the contribution to earnings of its overseas operations. However, IBM’s products and services help its clients improve their productivity and cut costs. The ongoing expansion of Internet banking and the online selling of goods should also spur IBM’s long-term growth. IBM should earn $8.72 a share in 2008, and the stock trades at just 9.9 times that estimate. It’s also cheap at 1.1 times its revenue per share of $75.50. The company will probably continue its policy of annual dividend increases. The current rate of $2.00 yields 2.3%. IBM is a buy.
