Editor’s note: Allan Krans is a senior analyst with Technology Business Research, an analysis firm based in New Hampshire. His analysis focuses on IBM’s quarter software results, part of Big Blue’s overall quarterly earnings report released on Tuesday.
HAMPTON, N.H. – IBM Software (is) doing more with less.
Adopting a strategy employed by customers around the world, the software division of IBM (NYSE: IBM) focused on doing more with less, delivering strong profit growth even as revenue growth slowed.
Much of IBM’s expansion plans centered on software during the past five years, and its 4Q08 results provided yet another validation for that strategy. IBM Software was the only division to maintain positive revenue growth in 4Q08, and delivered pre-tax margin of 43.4 percent, which is a record level for the division.
Operational Cutbacks Drive Margin Improvement
The fact that IBM Software was able to drive profitability to new heights while revenue growth slowed to 2.6 percent demonstrates the division’s commitment to bringing its cost structure in line with current economic conditions. IBM invested heavily in software as the economy and IT market expanded over the past five years, but there was a clear break from that strategy over the past six months.
The rate of acquisitions and operational investments was significantly curtailed as IBM braced itself for a slowdown in demand. As a result, IBM Software’s gross margin increased to 87.7 percent, the highest level in four years, and operating expenses decreased to 39.6 percent of revenue, a historic low for the division.
Investment in “Must Have” Initiatives Will Persist
Despite the strong operating expense control exhibited during 4Q08, IBM Software will continue to invest during 2009. Similar to its customers, however, TBR expects IBM Software’s investments to focus on areas that deliver the greatest returns in the shortest time frames, in contrast to the billion dollar software acquisitions seen over the past five years. IBM firmly believes that emerging geographies, the SMB segment, and the shift towards cloud computing all represent substantial opportunities for growth, and TBR expects the company to maintain or even increase spending to capitalize on these trends.
Shortly after the close of 4Q08, IBM announced the acquisition of Chinese SaaS email provider Outblaze, introduced the new LotusLive cloud computing service, and announced the IBM Business Partner Software Mid-Market Value Initiative.
Currency Takes a Bite out of Revenue Growth Rates
Excluding the effects of currency, IBM Software’s revenue growth was surprisingly strong given the current economic conditions. IBM reported that software revenue growth was 9% at constant currency, which is tied for its highest constant currency revenue growth rate for the past two years. In reporting its GAAP results, however, the strengthening U.S. Dollar caused actual revenue growth to shrink to 2.6 percent. After significantly benefitting from a weakening U.S. Dollar over the past two years, IBM and other U.S.-based companies will see reported growth rates significantly impacted by currency at least through 3Q09.
TBR believes the constant currency growth rates will take on greater importance during this time period, as it will provide a much more accurate picture of the company’s true financial health. TBR takes IBM Software’s 9 percent constant currency growth rate as a positive sign for the health of the division, and we expect reported growth to rise back to high single-digit territory once negative economic and exchange rate factors fade.