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A New, Respectful Way to Think About IBM

September 15, 1996|JAMES FLANIGAN

International Business Machines is doing better these days, no doubt about that.

The company introduced two lower-priced large computers last week that will allow its business customers to move mountains of data around their corporate systems and to reach customers through the Internet.

The result could be bursts of innovation from the customers and higher profits for IBM. And ultimately the new computers could yield a rejuvenating business for IBM thanks to related developments on the Internet.

Recovery continues at present. Analysts foresee the computer giant earning at least $6 billion this year on sales of $75 billion, continuing its comeback from the depths of 1993, when it lost $8 billion.

Yet investors are hardly turning cartwheels. IBM stock rose more than $6 last week to $122.125 a share, at least partly because all technology stocks got a strong recommendation. Still, that's only 11 times IBM's projected per share earnings of $11 a share; the average stock sells nearer 19 times earnings.

For all its size, breadth and history in the computer business, IBM today has a lower total stock value than do Microsoft or Intel, which supply software and microprocessors to IBM personal computers.

IBM stock remains far from its 1987 peak of $175.90 a share, although its price has more than doubled in recent years.

Why such disdain for one of the world's best known companies? Many investment managers have doubts about its future, bitter memories of the recent past when it disappointed investors, and even a feeling that IBM should be broken up.

"IBM has a lot of good businesses, but they're buried with lousy businesses," says Bob Djurdjevic of Annex Research, a computer consulting firm in Phoenix.

Djurdjevic has advised IBM executives to sell the personal computer business, which brings IBM $10 billion a year in sales but little if any profit.

He and other analysts would spin off the consulting and services division, which helps customers design and install computer networks, as a separate company. That division competes with EDS--newly independent from General Motors--and Computer Sciences Corp. But their stocks get relatively higher prices than IBM's.

IBM's software business, more than $12 billion in annual revenue, is another that analysts think could stand alone. The idea is that the sum of the separate stock prices would total more than IBM at present--"$180 a share," says Djurdjevic.

"That's interesting but short-term thinking," counters a retired IBM executive who asks to speak anonymously. If separated into parts, IBM would lose the "differentiation" that being a big company gives it, the executive argues.

He's referring to the technological possibilities that come from IBM's spending $4 billion a year on research and development and the capabilities that come from its $12- billion-a-year cash flow from income plus depreciation.

IBM's two new computers, part of its 390 series, are called servers--a jargon word meaning the combination of software and hardware that facilitates computer network communication. And that's significant. The new 390s will allow customers to refocus for the Internet the awesome amounts of data, estimated at 70% of all the customer and product information of U.S. big business, that are locked in IBM mainframe computers.

Loosening up those databases could greatly expand online custom retailing, financial services and other new businesses. The next few years could prove to be the dawn of real commercial industry on the Internet.

And IBM--which has systems to protect credit card and data security, as well as the computing power needed to maintain big networks--seems ideally prepared for this new era. Its massive network systems actually performed well at the Atlanta Olympics, even though glitches got most of the attention.

So why isn't the stock market saluting IBM's return to prominence? Because for the moment investors are infatuated with the innovations and growth of smaller companies, such as Sun Microsystems with its Java software, with which IBM is working jointly, and Netscape, with its browsers and server software, with which IBM also is working jointly.

The market pays premiums for profitability and growth. Microsoft, for example, earns 25 cents on every $1 of sales, compared with IBM's 8 cents. And, by no coincidence, Microsoft's relative stock price is three times that of IBM.

But smaller companies also have limitations. And when business really gets going on the Internet, the need for standards and greater capabilities will favor large companies, especially IBM.

"Because of the scale of its technological resources and its core competencies in computer networks, IBM will play a major role as the Internet evolves," says Andrew Grove, the chairman of Intel.

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