IBM Bear's Rebuttal
by David Forrest ([email protected])

Wow! I feel like a kid at Christmas with so many packages to open, I don't know where to start. Or, more appropriately, a bomber pilot with so many targets I'm not sure which to blow out of the water first. I don't blame Louis too much, though, as it's hard to make a good argument for a bad investment.

Louis writes:

In an otherwise gloomy market, old dependable is still up about 21% for the year. Moreover, the stock price has tripled over the last 22 months.

I suppose it's all in your perspective, but using the term "old dependable" for a company that has underperformed the market by more than 8.5% annually for the last 10 years seems a bit of a stretch. Underperformance is the only thing you've been able to depend on here.

In constant currency, revenues actually increased 8.3% last year and 5% in the first half of FY98. Not great but not bad either.

Not bad? 5% is "not bad?" You've got to be kidding. Can someone please tell me why I'm paying 21 times earnings for "not bad" 5% growth? I just don't get it. Louis calls IBM "overwhelmingly dull." He admits that "overall results of late haven't been all that impressive considering the opportunities at hand." Gross margins are down 5% in the first half of the year, Asia is weak, and hardware is in the dumper. Hip, hip, hooray.

Cost-cutting has been partly responsible [for increased EPS growth.]

All the cost-cutting in the world won't grow revenue. Yes, it's good that expenses as a percentage of revenue are coming down. Unfortunately, production efficiency, cost-cutting, etc., are all the result of "things gone wrong." In other words, when your costs are out of control, people praise you for cutting them. You fixed something that you broke. Congrats. Very little attention is being paid to things that go "right." In other words, new products, new innovations.

Yes, IBM spent a lot on R&D in nominal terms last year -- $4.9 billion is a lot of cabbage, but as a percentage of revenue it only spent 6%. Companies like Intel typically spend 10% or more of total revenue on R&D. I'm not terribly impressed by nominal numbers or patent awards, and you shouldn't be either. When I see new products introduced that revolutionize what IBM is doing, I'll change my tune. Until then, IBM is a fat, slow, and unexciting business.

Let me close by saying that I don't mean to be disrespectful to Big Blue. It tries hard. Its services business is very well respected and I know that some incredibly bright minds work there. However, unless it can compete on all levels of its business, it should break up the company, scrap what doesn't work well, and work towards beating the daylights out of everyone in the areas it IS good at. Will it? Probably not.

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