IBM’s Business Remixing

IBM announces earnings later today. I have written several pieces on IBM’s various activities, which can be found here, here, and here. In this post, I will look at IBM as a whole, and how their attempt to increase margins by increasing the software portion of the portfolio has been faring.

International Business Machines Corporation (NYSE: IBM) is one of the world’s largest IT company with revenues of $91.4 billion, in 2006. Based in New York, it operates in 170 countries with about 30% of its employees now in the Asia Pacific, as a result of worldwide restructuring. As per IDC, IBM is the leading services vendor with $49.3 billion in services revenue in 2006. It is also the leader in the worldwide server systems market with 31% market share. In the total worldwide disk storage systems market, it has 19.3% market share, close on the heels of HP with 20.6% market share. It is also a leader in the worldwide software configuration management market.

IBM’s operations are organized into six segments: Global Technology Services (GTS), Global Business Services (GBS), Systems and Technology Group, Software consisting mainly of Middleware and infrastructure software, and Global Financing. GTS and GBS are strategically combined as Global Services.

In 2005, IBM divested its PC business to Lenovo, exiting a fast commoditizing market to focus on higher margin software
businesses like service-oriented architecture (SOA), information on-demand, and business process services.

Acquisitions have been a key part of IBM’s software strategy and it has been on an acquisition spree , investing more than $16 billion in acquiring more than 60 companies in the past five years. In 2006, IBM invested almost $5 billion on 13 acquisitions, including FileNet ($1.6 billion), Internet Security Systems ($1.4 billion), Micromuse ($0.9 billion), and MRO Software ($0.7 billion). In 2007, it acquired DataMirror Corporation; WebDialogs, Inc., a provider of Web conferencing and communications services; Watchfire Corporation, a security and compliance testing software company; Softek Storage Solutions Corporation; DM Information Systems, Ltd. (DMIS); Consul Risk Management International BV; and Vallent Corporation. It has also announced its plans to acquire Telelogic AB.

On the financial front, IBM reported revenues of $23.8 billion for Q2 2007, an year-on year increase of 9%. Diluted earnings per share were $1.55, including 5 cents per share for gain from the sale of the Printing Systems Division (PSD).

Segment wise, Global Services revenues were up 10% year-over-year. GBS segment revenues increased 10% to $4.3 billion, benefiting from strong demand for SOA. GTS segment revenues went up 10% to $8.8 billion. Systems and Technology segment had revenues of $5.1 billion, an increase of 2%. Software revenues went up 13% to $4.8 billion. Global Financing segment revenues increased 4% to $597 million. Shares repurchased amounted to approximately $14.6 billion in the quarter. Its stock is trading around $118 and its market cap is $160.27 billion.

Looks like all is well, and the move to enhance margins by increasing the % of software in the business mix has gone well. There is, however, a slight complication looming in the horizon, which is worth a discussion. Oracle is about to acquire BEA systems, which will give it a portfolio of Application and Middleware software businesses. SAP already has both Application and Middleware in its portfolio mix. IBM, however, does not. It has more on the Middleware and infrastructure software areas, nothing in Applications. Is this likely to become a problem?

IBM also has Global Services, a business that addresses the integration needs of many large application software vendors, including Oracle and SAP. To the extent that Oracle and SAP are partially dependent on IBM’s services offering, and the fact that IBM actually benefits from these businesses, may be an argument in favor of IBM not owning any Application business. However, in Middleware, it does compete with some of its partners, and Global Services works with all the Middleware offerings in the industry.

The answer may actually lie in the domain of Software-As-a-Service (SaaS), where the application business landscape is still pretty wide open. Conceivably, IBM could acquire a bunch of mid-sized SaaS vendors, and get into the application software game through a high growth market.

In fact, I would go so far as to say that it would be a very smart alignment with its SOA business, and a good long term growth strategy to roll-up a few of the SaaS vendors.

Meanwhile, let’s see how the earnings come along.