IBM (click ticker for report: IBM) reported a strong second quarter Wednesday. The firm earned $3.51 per share (non-GAAP), $0.09 higher than the Street was expecting and up 14% compared to the same quarter a year ago. Further, the firm raised its full-year earnings outlook to at least $15.10 per share, from its previous guidance of at least $15.00 per share. Revenues fell about $500 million short of expectations, coming in at $25.8 billion, or down about 3% year-over-year. However, without the impact of currency fluctuations, revenues grew 1% year-over-year. Although it seems the firm is on track to reach its 2015 goal of earning per share of at least $20.00, we think shares are fairly valued.
As has been the case for technology firms, second quarter performance diverged on a geographic basis. Revenues in the Americas were down 1% for the quarter (up 1% ex-currency) to $11.1 billion, whereas revenues in Europe/Middle East/Africa (EMEA) fell 9% (flat ex-currency) to $7.9 billion. Revenues in Asia-Pacific grew 2% (4% ex-currency) to $6.3 billion. The firm also noted that revenue growth in BRIC countries (Brazil, Russia, India and China) grew 5% year-over-year—but a whopping 12% adjusted for currency fluctuations. We think the firm’s ability to win market share in emerging markets will be crucial to its ambitious growth goals, so the firm’s strength in the BRIC nations is very encouraging.
IBM’s full-fledged transition from hardware dinosaur to software and services remains intact. Global Technology Services revenue declined 2% (up 2% ex-currency) to $10 billion; however, the segment’s operating margin grew to 17.1%, boosting pre-tax earnings in the segment 24%. Revenues in the Global Business Services were not nearly as strong, falling 4% (-1% ex-currency), with pre-tax income only growing 7%. We suspect some of the firm’s focus on cost-cutting (SG&A down 3% on a year-over-year basis) helped drive increased profitability gains. Though the backlog fell 6% compared to the same period last year, we think the firm’s $136 billion services backlog is still quite healthy.
The high-margin software business also experienced strong results, with revenues coming in flat year-over-year (up 4% ex-currency) at $6.2 billion. Though this business isn’t quite as strong as services, we’d like to see management focus on strategic acquisitions that can boost profitability in this segment. We look at Intel’s (click ticker for report: INTC) acquisition of McAfee as the perfect software acquisition model. Instead of buying a “hot” software firm that will eventually be written-off—think some of Microsoft’s (click ticker for report: MSFT) recent acquisitions—McAfee has become a crucial part of Intel’s product mix.
Though IBM, like its competitors, will encounter currency headwinds, we’re encouraged by the firm’s results and think the firm should continue to successfully execute its plan to get to $20 per share in earnings by 2015. IBM generated $3.7 billion in free cash flow in the second quarter, and now has $11.2 billion in cash on hand to fuel share buybacks ($3 billion in the second quarter), dividends and acquisitions. Although we like the company’s recent performance, we think shares are fairly valued at current levels. To gain exposure to the technology enterprise space, we prefer Microsoft, which we hold in our Dividend Growth Newsletter portfolio.