IBM Business Remix Boosts Earnings

This week, IBM (NYSE:IBM) reported fourth quarter and fiscal year 2009 results that beat estimates. Although it was modest, IBM did record slight revenue growth in the fourth quarter after more than a year of no growth. The company’s focus on software and services has helped it to boost its earnings. 

Over the past decade, IBM has exited “commoditized” businesses to invest in the more profitable business of software and services. Since 2000, the company has invested about $22 billion to acquire 108 companies, including the $3.5 billion acquisition of PricewaterhouseCoopers Consulting. Since 2005, the company has invested $10 billion in 14 acquisitions, including the $5 billion deal with Cognos to build its business analytics capabilities. In 2009, it invested in Smarter Planet solutions, cloud computing and advanced analytics, a move that should position IBM for growth as the economy recovers. At the recent Lotusphere, IBM demonstrated Project Vulcan, which attempts to bring together its Lotus messaging and collaboration suites with social and business analytics. IBM wants to extend Project Vulcan to the mobile enterprise, too.

IBM has already started reaping the benefits of this business remix. In 2000, software segment pretax income (PTI) was $2.8 billion; in 2009, it had almost tripled to $8 billion. In 2009, over 90% of its segment profit came from software, services, and financing, with software and services each contributing 42% of the segment’s PTI.

As for IBM’s financials, Q4 revenue was up 1% y-o-y to $27.2 billion versus analyst estimates of $26.98 billion. Net income grew 8.7% to $4.8 billion or $3.59 per share, beating analyst estimates of $3.47 per share. For the full year 2009, revenue was down 8% to $95.8 billion and net income was down 9% to 13.4 billion or $10.01 per share. Q3 analysis is available here.

Gross profit margin improved to 48.3% from 47.9% last year and 45.1% last quarter, led by better margins in both the services segments and the Systems and Technology segment. For the full year, gross margin was 45.7% versus 44.1% in 2008. IBM ended 2009 with $14.0 billion in cash on hand and generated free cash flow of $15.1 billion, up more than $800 million y-o-y. In 2009, the company paid $2.9 billion in dividends and bought back shares for $7.4 billion. Debt totaled $26.1 billion, down from $33.9 billion in 2008, with Global Financing debt at $22.4 billion versus $24.4 billion in 2008.

By region, full-year revenue from the Americas was down 6% to $40.2 billion, EMEA was down 12% to $32.6 billion, and Asia-Pacific was down 2% to $20.7 billion. OEM revenues were $2.3 billion, down 15% from 2008.

By segment, Systems and Technology revenue was $16.2 billion, down 16% y-o-y, and Software revenue was down 3% y-o-y to $21.4 billion. Global Financing revenue was down 10% to $2.3 billion. Global Technology Services revenue was down 5% to $37.3 billion and Global Business Services revenue was down 10% to $17.7 billion.

During the fourth quarter, the total value of IBM’s new services contracts increased 9% to $18.8 billion, including 22 contracts greater than $100 million each. Based on its performance, the company expects full-year 2010 diluted EPS of at least $11.00. In May 2007, IBM had set an EPS objective for 2010 of $10 to $11. Despite a challenging economy, it achieved EPS of $10.01 one year earlier than it expected, in 2009. The stock is currently trading around $134 after hitting a 52-week high of $132.97 on January 4. Market cap is about $176 billion.

IBM’s consulting sales haven’t picked up much even as there is a recovery in information technology spending, while HP, which has kept its PC business, is seeing sales increase. My next post on HP will review how that company’s business remixing has played out. Conventional wisdom would say that HP and Dell should get out of PCs and let the Chinese take that business since it is so price-sensitive and low-margin. IBM’s business remix follows that wisdom. But HP’s doesn’t. I wonder what’s going on in Mark Hurd’s head?