Big Blue’s Crystal Ball Shows Gains in Software, Emerging Markets

IBM executives told investors Thursday they see a future where the technology giant grows profits significantly by expanding the amount of income from software sales and by tapping into emerging markets.

Big Blue expects to boost the total percentage of its net income coming from software to 50 percent from the current 40 percent by 2010, part of a larger shift away from lower-margin endeavors, best exemplified by the company’s decision to exit the personal computer business.

IBM will see profit gains from its services business, and predicted that revenue from emerging markets will double over the next three years, CEO Sam Palmisano said.

A Long-Range Outlook

The comments came during a briefing for investors held at IBM’s T.J. Watson Research Center in New York. While many public companies hold updates for analysts and investors, the fact that IBM gave such a long outlook is somewhat unusual, and shows how the company is evolving and relying more on profit growth than pure top-line revenue growth.

Overall, IBM said future profits could be significantly higher due to a combination of factors, including the move into more profitable business lines — and away from traditionally thin-margin businesses such as low-end hardware — and an ongoing effort to reduce the number of outstanding stock shares through buyback.

Per-share profits could rise to US$11 by 2010, Chief Financial Officer Mark Loughridge said, a significant jump over the $6.11 per share in net income IBM posted in 2006.

The company is comfortable with giving such a long-range outlook because it has created a strategic “road map” that in turn “gives us a lot of confidence in our business model,” Loughridge noted.

New World Order

The presentations spurred some optimism from investors. On Friday, IBM saw its stock reach a new 52-week high, with shares trading up almost 2 percent to $107.30.

The additional profit would come in part from growth, IBM said, in part from ongoing efforts to cut costs and make existing businesses more profitable and in part from potential new acquisitions and product initiatives. Stock buybacks alone — IBM has completed or has planned some $40 billion worth of buybacks — could add more than $1 per share to annual earnings.

The rosy outlook relies in part on IBM finding new growth markets, and Palmisano argued that Big Blue is actually better positioned than many of its rivals to grow its share of IT spending take in markets such as India, China, Brazil and Russia.

Some of the growth will also come from IBM’s technological innovation. For instance, IBM expects virtualization to provide it as much as $1 billion in operating profit in coming years as it provides software and services to help businesses do more with their existing servers and mainframe computers.

IBM is also hoping to break new ground in chip-making, recently announcing that it had developed a technique that uses nanotechnology and natural processes similar to those that build seashells to allow microchip components to essentially assemble themselves, using tiny air pockets as insulation. That technique could change how chips are made and reduce the amount of heat they produce inside PCs and other machines.

Growing and Slowing

Investors have been high on IBM since it boosted its annual dividend last month and said it would add another $15 billion to its buyback program.

Meanwhile, IBM may be signaling that some of the growth investors have come to expect may be harder to find in established markets such as the United States. In its most recent quarterly results, IBM posted just 1 percent growth in North American sales, noted Gartner analyst Martin Reynolds.

“There are mixed signs about how strong tech spending is going to be for the foreseeable future and there’s larger questions about the economy overall,” Reynolds told the E-Commerce Times. With that in mind, many tech companies are positioning themselves to tap into overseas growth by establishing a presence on the ground in places such as India and China.

For IBM and others, hardware sales typically offer smaller margins, while software has more profits built-in and can offer the opportunity for more renewable revenue.

IBM has been laying the groundwork for the software shift for some time, said UBS analyst Ben Reitzes, with more than two dozen acquisitions during 2005 and 2006 alone.

“There is a software shift, and IBM is still in the early stages of it,” Reitzes told the E-Commerce Times. At the same time, even though it generates less profit per sale, the services unit continues to perform well, creating new opportunities for Big Blue to sell software now and in the future, he added.