This time last year,
was one of the market's hottest stocks, riding the updraft of CEO Lou Gerstner's reformulation of the company as an e-business juggernaut located squarely in the sweet spot of the fast-growing Internet economy. But recent action has reminded investors just how dependent the company remains on old Big Iron.
Worries over the near-term performance of IBM's mainframe-hardware business have sent a number of stocks reeling this week. Mainframe-software makers
both have gotten hammered after warning of revenue shortfalls that they blame on customers' decisions to defer purchases until IBM's new
mainframe product rolls out later this year. IBM itself has lost more than 7.2% in the past two days amid fears that its customers have been making similar decisions.
Big Blue has heavy exposure here. Analysts estimate mainframes contribute 20% to 25% of the company's revenue, much of which includes software and support services, but all of which is pinned on the hardware products themselves. And the hardware business is hardly exploding.
estimates that unit shipments of mainframes will grow at a compound annual rate of just 2% between 1999 and 2004. Hardware revenue, meanwhile, is actually expected to decline by 5.3% over that period.
Owning the Business
IBM has remained committed to such a low-growth business for a very simple reason: Mainframes represent a mature market that's capable of generating loads of cash with fat profit margins. And IBM virtually owns the business.
pulled out last year, they really let IBM take over the high-end market space," says Steve Joslin, an analyst at International Data, which has done consulting for IBM. "It's an IBM-dominated store. We don't see this platform going away by any stretch of the imagination. There is too much corporate data still on the S390 platform." The S390 refers to the high-end mainframe platform, a market of which IBM held about 82% last year, according to IDC.
"It's still a very profitable business, as is any business where you're the dominant vendor," says
Deutsche Banc Alex. Brown
analyst Phil Reuppel, who rates IBM a strong buy and whose firm hasn't done any underwriting for the company. "It's just not a growing segment. The company continues to find ways to modify the products to open it up and make more customers comfortable with buying the product. But we've seen a lot more growth in other segments on the hardware side, especially
and, at the low end,
A Gradual Shift
IBM's movement away from mainframes has been gradual so far, the strategy marked by more of an effort to expand higher-growth business lines than by pulling back from a well-established S390 customer base. Meanwhile, analysts stress that the mainframe slump is a near-term problem.
"Whenever IBM announces a new-generation mainframe, there's generally a lull three to six months in front of that," says Andy Neff, a
analyst who rates the stock a strong buy and whose firm hasn't done any underwriting for IBM. "For customers, if you've got something new coming, you pause to assess it."
In the meantime, more and more investors seem to be coming to the realization that IBM is just not the hyper-growth company many had hoped the Internet could help it become. The stock has fallen nearly 25% in a year.
"They're just kind of falling behind everybody," says Craig Johnson, portfolio manager at
Leonetti & Associates
, which unloaded about 222,000 IBM shares in the first quarter. "When we held it, people were willing to pay a premium. Now people are saying, 'I don't mind paying fair value, but I don't want to be paying a lot for the stock.' "
That's especially the case this week. A number of analysts already have expressed concern about the company's second-quarter earnings, which are expected to be released during July's third week. Bear's Neff, for one, has cut his quarterly earnings-per-share estimate to 97 cents from $1.02.