Saturday, April 27, 2013

Why I Bought More IBM

t’s rare that I recommend watching a movie in order to try to understand investing, but in this case I strongly suggest finding the time to look at the late great Akira Kurosawa's masterpiece ‘Rashomon.’ The film is about the relativity of truth and depicts how three different people recall (in contrasting fashion) what is broadly the same event. Tech investors will have an inkling of what I ‘m talking about already because IBM (NYSE: IBM) became the latest company to disappoint with earnings. The problem is that the reasons for these misses are becoming ever more varied.

Time Heals Everything

IBM’s great rival Oracle (NASDAQ: ORCL) also gave weak results recently and insisted they were largely due to sales execution. Fast forward a few weeks and Fortinet (IT security) and F5 Networks (application delivery controllers) both argued that their telco verticals were weak in the quarter.  Red Hat missed estimates and Verizon discussed an ongoing cautious spending environment amongst enterprise customers. TIBCO Software (NASDAQ: TIBX) missed and guided lower and gave its--now all too familiar-- refrain that its sales execution wasn’t up to scratch but that it would all be sorted out soon enough. Although frankly I think it would be just as interesting to now hear what the sales guys said about the management. 

Just as with Rashomon, all we do know now is that we have dead body on the scene even if the exact story isn’t entirely clear.The good news is that we can get a bit more detail from the crime scene.

Let’s put it this way: if it truly is a question of a bit of excess caution being caused by political uncertainty over the sequester (Oracle’s quarter end fell on the deadline) then as companies report through the ongoing earnings season we might expect to get a bit more color on any pick-up in demand. Indeed, I think IBM may well have just done that. Oracle’s numbers ran to the end of February while IBM’s ran to the end of March. A lot can happen in a month.

Who Said What

In essence Oracle said that it expected to bounce back in its Q4 and that the pipeline was up significantly. Its miss was largely a result of sales execution and timing issues rather than competitive losses or businesses walking away from future deals or even trying to reduce the size of them. TIBCO said a similar thing.

Fast forward to IBM, and in the latest report we hear about issues relating to sales execution, the timing of Easter, the sequester, $400 million of software and mainframe revenues rolling in to the next quarter, the weather and even the change in the Chinese Government.

The conclusions of which led to some disappointing revenue growth numbers for IBM in the quarter.

Superficially it is worrying, but unless you believe that all these tech firms (TIBCO, IBM and Oracle) have suddenly seen their sales managements lose the ability to sell, then the real cause of this slowdown in tech spending (and I think it’s time to call it that) is probably due to some caution around the sequester. IBM reported in September that orders had fallen over a cliff only to see a nice rebound in the next quarter.

Furthermore, none of these companies are blaming the macro environment or seeing their pipelines diminish, so if you are bullish on the economy then there is every reason to expect that this order weakness will prove temporary.

The Bottom Line

I think my line of argument applies to all three companies, but they differ in their attractiveness. Frankly, TIBCO really needs to report a couple of good quarters and regain investor confidence.  It appears to have more issues than just sales execution. Oracle is attractive in this viewpoint, but longer term it faces risk as it refreshes its hardware. It also has to demonstrate that it can continue to be as dominant in the cloud based era as it is with on-premise

For IBM, the response to the weak quarter is to take some workforce rebalancing in Q2, and if recent reports are true it is prepared to sell some low margin hardware businesses.  All of which is in line with its long term objectives to go for margin improvements by divesting and reducing lower margin sales. Even in this bad quarter IBM managed to increase gross and operating profit margins.

Moreover, despite the weaker numbers this quarter it didn’t lower its full year earnings guidance. The company is still forecast to deliver double digit earnings growth in the next couple of years while generating huge amounts of cash flow. I think the sell-off is a decent buying opportunity so I bought some more.

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