A Blue Chip Again

WASN'T IT ONLY A YEAR OR two ago that IBM was considered a "dinosaur"? You know, one of those plodding, money-losing corporate behemoths, slouching toward the tar pits of extinction. So how come its stock is up more than 40 percent since January, to $118? What was it doing last week, touting its juicy profits and rewarding workers with raises and bonuses? And what's this talk of a fat dividend come April?

Maybe we had in mind the wrong kind of dinosaur. These days IBM looks more like some born-again T-rex, rampaging down Wall Street. How hot can you get? Other tech stocks have been slumping; IBM keeps going up and up. Industry analysts who bad-mouthed its shares at $48 two years ago now think the stock could hit $150, within striking distance of its 1987 high of $175. Certainly the company's prospects are the best in years. In January the company reported record 1995 revenues of $71.9 billion; earnings were up 38 percent, to $4.2 billion. Big Blue is blue chip again. Does that mean we should do as many brokers advise and "buy"? Perhaps not just yet. IBM may be on a roll, but don't necessarily expect more of the same for '96. instead, look to '97. That's when IBM could really blow it out.

But first, some reasons for caution. One is the sheer fickleness of good luck. Last year IBM got some breaks that probably will not recur. For instance, currency gains on the falling dollar pumped as much as 15 percent into IBM's revenues. (This year, by contrast, the dollar is rising.) A clutch of one-time tax breaks similarly boosted fourth-quarter earnings. Rob Enderle, a former IBM senior executive now at Giga Information Group, suspects the company may also have "padded" its latest results by booking orders for early '96 delivery as if they had occurred in '95. (IBM says it doesn't engage in such practices.) "I'm real nervous," Enderle says. "The first quarter of '96 could be bad," if only in comparison to the Street's expectations.

The coming year may be one of consolidation for more fundamental reasons, as well. Think of IBM's recovery as a drama in three acts. Act I was downsizing. After losing $8.1 billion in 1993, IBM laid off tens of thousands of employees and chopped everything from secretaries' salaries to the corporate art collection. Act II was growing IBM's revenues. So far, so good. IBM calculates that 57 percent of its revenues last year came from so-called growth sectors of the computer industry, expanding at an annual rate of 19 percent. Among them: consulting services and software for the Internet. Trouble is, the remainder of its businesses shrank by 3 percent--and generated precious little revenue. Hence, Act III: turning those marginal performers into moneymakers, even as IBM plumps its winners.

That won't be easy. Part of the challenge involves the company's bread-and-butter business in mainframe computers, accounting for roughly half its earnings. Demand was up by 60 percent this year (though overall revenues rose just 15 percent). Even enthusiasts concede that might taper off a bit. Reason: back when pundits were proclaiming "big iron" to be all but dead, corporate information managers hesitated to buy. Last year, with mainframes officially "back," purchases spiked upward. But that could be temporary, propelled by what Bob Djurdjevic at Annex Research in Phoenix calls "pent-up demand." In 1996, he predicts, "demand will return to more normal levels," taking some of the oomph out of sales.

There are other problems:

Major competitors like Amdahl and Hitachi are nibbling on IBM's market. Both will begin shipping rival new mainframes by the second half of the year.

IBM's $10.7 billion personal-computer business turned a profit in 1995, after losing $1 billion in 1994. The downside is that profit margins for the PC industry, always thin, are shrinking even more.

The company's software group is struggling, most notably with Notes, the networking software IBM acquired with Lotus Development Corp. last year for $3.5 billion. Chairman Louis Gerstner saw the deal giving IBM 34 percent of the fast-growing networking market, to Microsoft's 12 percent, but it may prove a passing advantage. Why? Notes has been blindsided by the Internet, which lets people exchange data and e-mail just as efficiently but less expensively. AT&T drove home the point last week, when it dropped Notes as the backbone of its nascent Internet service. "Lotus peaked just when IBM bought it," says consultant Bill Laberis, until recently editor of ComputerWorld. "Now it's going into decline." Gerstner wouldn't comment, but an IBM spokesman disagreed, noting that under its ownership Lotus sold three times as many copies of Notes last year as it did in all previous years combined.

For all those challenges, IBM seems destined to thrive. That's because the biggest trends in the computer industry are going its way-chiefly the so-called Internet revolution, despite its effect on Notes. During the past year computing moved decisively away from the model that marked IBM's decline - the birth of stand-alone PCs. The new model is "networked computing," systems of PCs, workstations and larger "servers" all linked together, spanning the workplace and the world. Why is that good for IBM? Because building and managing complex information systems is what IBM has always done best, ever since the heyday of the mainframe. As companies struggle to hook up to the Internet, or create the private networks known as intranets, many are logically turning to IBM. Some want it to help them integrate different generations and makes of computers into a single easy-to-use system; others want to "outsource" the whole show-essentially handing over their entire data-processing operations to IBM. Says Sam Palmisano, head of IBM's integrated-systems group: "It's as if the whole industry has come around toward our traditional strengths."

The effect on profits will be dramatic. Four years ago IBM didn't even offer such services. Last year they contributed $12.7 billion to its revenues and $1.8 billion to net income. That's approaching half of IBM's total earnings and, significantly, almost as much as the company made selling mainframes. What's more, the business has been growing between 20 and 30 percent annually. Small wonder that John Jones of Salomon Brothers considers IBM cheap at $140. At that ratio of price to earnings, he says, IBM's shares would still be selling at a "discount of 35 percent" compared with other healthy blue chips. Annex's Djurdjevic thinks similarly. If IBM's "crown jewels"-the services, software and mainframe groups-were valued as independent companies, with their shares priced in line with their competitors', they would be worth nearly twice what the entire company is today. In other words, there's a lot of hidden value in IBM, not reflected in its stock. Could it be that it is once again a safe investment for widows and orphans, a little something for a nest egg? Once IBM is over the bumps of '96, it may well be.