Over the past few years, IBM (NYSE:IBM) has been transforming its business. The company divested its PC business to Lenovo, as well as other commodity businesses (such as displays and hard drives). There has also been a spending spree on software companies.
And things are starting to improve, but will the positives continue into 2007?
Here's a look:
Challenges to overcome
For the past year, IBM's global services business has been a slog. Simply put, the company has been inconsistent in terms of contract signings.
But it must compete against a variety of offshore players, such as Infosys (NASDAQ:INFY) and Wipro (NYSE:WIT). These companies not only have a low-cost wage advantage, but have built sophisticated platforms to provide information technology services.
In fact, as IBM becomes a mega player in software, there remains a big issue: Might clients be resistant in hiring the consulting division? After all, will IBM be tempted to focus on its own products?
Opportunities in 2007
With about $90 billion in revenues, it's extremely difficult to grow the top line. Keep in mind that a 5% increase is the equivalent of a Fortune 500 company.
Thus, IBM has been focusing on improving its profit margins. To this end, the company has lasered in on productivity initiatives, such as improving supply-chain management and restructuring the workforce. And, yes, management plans to continue these efforts into 2007.
Interestingly enough, the lagging services revenues appear to be an indicator of this strategy. How? Well, the company is taking a much more disciplined approach in terms of bidding on contracts. True, this means passing on some deals. But, in the high-stakes IT consulting business, a bad contract can be costly (in terms of penalties and even lawsuits).
Finally, IBM's significant investment in software should help improve margins. What's more, the company can leverage these investments across its global platform of customers, which could be an opportunity to upsell consulting services.
Quick valuation
As I write this, IBM's stock is up close to 17% year to date. But it has lagged other major tech players, such as Oracle (NASDAQ:ORCL), which is up 44%, and Hewlett-Packard (NYSE:HPQ), which is up 39%. Actually, IBM looks fairly cheap compared to its peers:
|
Price-Earnings Ratio |
Enterprise Value/Sales |
Enterprise Value/EBITDA | |
|---|---|---|---|
|
IBM |
16 |
1.73 |
9.32 |
|
Microsoft |
24 |
5.92 |
14.30 |
|
SAP |
28 |
4.92 |
16.31 |
|
Hewlett-Packard |
18 |
1.07 |
10.16 |
The Foolish bottom line
So far this year, Big Blue has thrown off $7.3 billion in cash from operations. Moreover, it has returned $7.9 billion to shareholders (most of which most was in the form of share buybacks). Yet the company still has $10.9 billion in the bank.
Given its move towards higher-margin businesses, the cash flow should continue to be strong in 2007. In other words, IBM's stock seems attractive to me, as it has room to catch up with the valuations of other big-cap tech companies.
Further Foolishness:
Check out the other companies featured in "The Motley Fool's 2006 in Review and 2007 Preview" special.
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Fool contributor Tom Taulli does not own shares mentioned in this article. He is currently ranked 758 out of 17523 in CAPS.
