Earnings Preview: IBM

International Business Machines Corp. (IBM) is expected to announce its first quarter 2011 results after the closing bell today. Currently, estimate revisions have moved in both directions over the last few days, so we continue to expect a modest beat in this quarter.

The Zacks Consensus Estimate for the first quarter is pegged at $2.30, implying an increase of 16.8% from $1.97 reported in the prior-year quarter.

IBM posted an average earnings surprise of 1.93% in the trailing four quarters, implying that it has outdone the Zacks Consensus Estimate by the same magnitude during this period.

IBM reported earnings of $4.18 in the fourth quarter of 2010, surpassing the Zacks Consensus Estimate of $4.08. Revenue increased 6.6% year over year to $29.02 billion, well above the Zacks Consensus Estimate of $28.27 billion.

Growth was witnessed across all major markets (U.S., France and Italy) with revenues climbing 5% at constant currency. According to management, the fourth quarter posted the best revenue growth at constant currency in almost a decade, primarily driven by higher Hardware and Software revenues.

The developing markets comprising the BRIC (Brazil, Russia, India and China) nations recorded a 19% revenue growth. For further details, please see IBM Beats On Strong Revenues.

IBM is expected to post strong revenue growth in the first quarter. Currently, the Zacks Consensus Estimate for revenue is pegged at $24.04 billion, up 5.2% year over year from $22.86 billion reported in the prior-year quarter.

We expect continued growth from emerging markets (29.0% of total systems revenue in 2010) in the first quarter, particularly from the Asia-Pacific region. The company expects its served markets to grow at least 40% by 2015.

During the first quarter, IBM announced that it will invest $38.0 million to build a new Cloud Computing Data Center in Singapore, scheduled to be operational from April. IBM has 13 global cloud labs, of which seven are based in Asia-Pacific countries including China, India, Korea, Japan, Hong Kong, Vietnam and Singapore.

The investment in Singapore signifies the increasing demand for cloud solutions and services in the Asia-Pacific region. The Asia-Pacific market for cloud computing is set to grow 40% per annum through 2014 to $4.9 billion and IBM is well placed to benefit from this growth.

IBM also commenced a new Power Systems development laboratory in Taiwan. This new facility is IBM’s first research center outside the US.

However, the natural disaster in Japan (which contributes roughly 11.0% to the total revenue) is expected to impact IBM’s top-line growth in the first quarter. Japan was struck by a tremendous earthquake and deadly tsunami on March 11, 2011. IBM reported that it failed to estimate the possible impact of the disaster on its operations at the time.

We also believe continued volatility in outsourcing signings can hurt IBM’s profitability in the first quarter. Outsourcing constitutes more than half of all IBM’s new services deals in a given quarter.

IBM announced only four deals in the first quarter versus seven in the year-ago quarter, and only one was valued at more than $100 million. However, not much data around its service bookings are available right now. This lack of visibility can also hurt IBM’s top-line growth in the near term.

In the first quarter, we believe IBM’s Software segment will benefit from the acquisitions of Netezza and Sterling Commerce that were completed in 2010.

IBM remains focused on expanding its product portfolio and leveraging its global scale through accretive acquisitions that can be easily integrated into its current businesses.

In 2010, IBM completed 17 acquisitions, with the Software segment acquiring 13 companies, the Systems and Technology segment acquiring 2 companies, and the Global Business Services (GBS) and the Global Technology Services acquiring one each. These acquisitions will boost IBM’s top-line growth going forward.

Estimate Revision Trend

Of the 22 analysts providing estimates for the first quarter, 2 revised their estimates upward in the past 30 days, while 2 moved their estimates downward.

In the past seven days, only one analyst revised estimates upward, while another analyst made a downward revision.

The net impact of the estimates revisions was nil.

We remain optimistic about IBM’s long-term growth based on its growing initiatives in the Smarter planet, business analytics and optimization and cloud computing areas.

However, we remain Neutral over the long term (6-12 months) due to increasing competition from a number of companies, including Hewlett Packard Co. (HPQ), Microsoft Corp. (MSFT), Oracle Corp. (ORCL) and EMC Corp. (EMC).

IBM shares have risen 10.6% since the fourth quarter earnings release and we believe they are fairly valued at these levels. Consequently, we believe the shares will remain range bound in the near term.

IBM has a Zacks #3 Rank, which translates into a Hold rating over the short term.

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