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Highlights
IBM Global Services' results for Q1:11 were mixed, but disappointing overall. This piece explains IT
services industry implications from IBM's report and our follow-up discussion with management.
On the somewhat positive side, overall Global Services revenue growth improved from 2% in Q4:10 to 3%
in Q1:11, and we see indications that add-on work is helping outsourcing revenues.
On the concerning side, IBM's "transactional" services business showed disappointing revenue and
signings growth, in contrast to Accenture's impressively strong growth results. This could cause investors
to question the strength of the demand recovery in the consulting & systems integration market. However,
importantly, we discuss reasons why we argue IBM's consulting & systems integration business is
meaningfully different than Accenture's and the Indian firms' (with our argument supported by Exhibit 1).
And, due to these reasons discussed herein and our other research based reasons to be confident in the
demand of Accenture and the top Indian firms, IBM's latest report is not causing us to question our industry
thesis or estimates. Briefly stated, we see several reasons why IBM's "transactional" services growth
pattern tends to be weaker than Accenture's during major recovery periods.
Also, we see further evidence that the traditional IT outsourcing market has matured (e.g., IBM's
outsourcing backlog declined $0.5 billion Y/Y in CC), and we view this as an ongoing issue for CSC.
Disappointing data points in IBM's "transactional" services category… Government business a drag
In Q1:11, IBM's transactional services revenues grew 6% in US dollars and 3% in constant currency
(CC), showing a modest improvement from 2% (in CC) in the prior quarter. And, transactional services
signings grew -1% in US dollars and -5% (in CC), reflecting substantially deceleration from +9% (in CC)
in the prior quarter. Note: IBM's "transactional" services category includes consulting & systems
integration services. By comparison, Accenture's consulting segment in the February 2011 quarter
achieved revenue growth of 20% and signings growth of 13% (in CC). What happened to IBM?
IBM says its government business was a substantial (and more than expected) drag on its transactional
services growth – i.e., excluding government business, transactional services revenue and signings
growth was around 5% in constant currency (to clarify, weakness in government had more impact on
signings growth than on revenue growth). Note: We believe government/public sector drives
somewhat greater than 15% of IBM Global Services' revenue and a similar mix of 16% for Accenture.
Three months ago, we think IBM was confident that its Global Services revenue would show acceleration
over the next year. Today, we think IBM is less confident about this. And, based on its weak signings in
Q1:11, we think IBM's consulting/systems integration business could decelerate in the near term.
How can IBM's transactional services business be so weak compared to Accenture's consulting business?
IBM did not give answers to this question. But we maintain Accenture's consulting business is experiencing a
decidedly strong demand phase that should last multiple quarters. And, we see several reasons why IBM's
"transactional" services growth pattern tends to be weaker than Accenture's during major recovery periods:
IBM's consulting & systems integration business has a tendency to recover less dramatically than
Accenture's. In Exhibit 1, to support this point, we've compiled consulting segment growth data for IBM
and Accenture (with efforts to exclude the impact of currency, major acquisitions, and segment
classification changes). This exhibit shows that Accenture's consulting segment during 2004 to 2007 (in
the demand recovery period after the bursting of the Internet bubble) showed a faster and more consistent
growth recovery than IBM's consulting/systems integration business. Moreover, it should not be
surprising if Accenture's consulting growth pattern in today's demand recovery proves to be stronger than
IBM's; this has certainly been the case in recent quarters. In other words, Exhibit 1 shows that the
consulting growth patterns of IBM and Accenture can be quite different, particularly during major
recovery periods, and this provides some evidence that lackluster consulting growth at IBM of late
should not cause Accenture's consulting demand to be called into question.
Accenture is better positioned to capitalize on transformational services demand, which we maintain is
central to the demand phase that is now underway in the services industry. In fact, instead of IBM, we
think the consulting arms of the accounting firms are more important competitors for Accenture today,
given the type of consulting now seeing increased demand. Further, we think Accenture is generally
better than IBM at driving add-on consulting revenue from existing clients (i.e., revenue that is not
backlog-driven), plus the current recovery cycle (and clients' increased willingness to invest in
transformational initiatives) is making such add-on consulting business more in demand – with
Accenture likely benefitting more than IBMGS. At the same time, we underscore that these same
positioning differences tend to make IBM's consulting growth more resilient than Accenture's during
periods of macro-shock when demand for add-on business abruptly drops.
IBM has been more focused on profit growth than revenue growth. For instance, IBM can legitimately
argue that it is improving the mix of its services revenues -- i.e., moving toward higher margin services
and toward services that support the growth of IBM's product businesses (e.g., analytics, Smart Planet).
IBM's growth is more wed to emerging countries than Accenture's (and we see structural reasons for
this). And, while IBM's growth from emerging countries is currently strong, it's not currently
contributing a substantial incremental boost to IBMGS' overall growth. In contrast, Accenture's growth
and the top Indian IT services firms' growth rates are more wed to developed countries, where growth is
now generally seeing demand recovery inflection points. Note also that we think Accenture has a future
opportunity to derive more growth from emerging countries.
Traditional IT outsourcing market is mature, though cyclical factors can help
IBM's outsourcing services category experienced growth acceleration from 2% in Q4 to 4% in Q1 (in
constant currency). We would attribute a good portion this improved growth to cyclical factors that
likely helped add-on work and volumes to improve under existing outsourcing contracts
On the secular side, we see further evidence of maturation in the traditional IT outsourcing market,
particularly in developed countries. IBM's outsourcing backlog of $95 billion, after accounting for
currency effect, declined by $0.5 billion over the last year.
On a related note, see our 4/6/2011 research piece, explaining that we think the traditional IT
infrastructure outsourcing market is actually shrinking (see research link – IT Services: Traditional
Infrastructure Outsourcing Market Is Melting, While Cannibalistic RIMO & Cloud Offerings Heat Up).
Data included in this piece, and highlights of additional data points
Exhibit 1 compiles historical data on Accenture's and IBM's consulting revenue growth history. Exhibits 2
& 3 serve as dashboards, conveying IBMGS’ trends in revenue growth, margins, and signings by segment.
And, in Exhibit 4, we calculate IBMGS' backlog erosion.
To highlight additional data points from IBMGS' Q1:11 report:
Overall services signings were below expectations: IBM reported total signings of $10.5 billion (-18%
Y/Y growth), versus Bernstein's forecast of $12.6 billion.
Mixed data points in outsourcing business: IBM's outsourcing-category signings posted Y/Y growth of
-30%, versus +23% in the prior quarter and -8% in the year-ago quarter (in constant currency). We think
IBM's strong signings in Q4 impacted deal flow in Q1. On a more positive note, outsourcing services
revenues showed +4% Y/Y growth, which reflects improvement from +2% achieved in Q4:10 (again, we
think cyclical factors, such as add-on work, helped outsourcing revenue growth). Also, IBM reiterated its
"backlog roll-forward" analysis that suggests its outsourcing business should be able to achieve +3%
growth in 2011 from backlog (i.e., excluding growth that could stem from additional signings). Overall,
given IBM's exposure to the substantially mature IT infrastructure outsourcing market, we do not have
high expectations for IBM's outsourcing signings growth in 2011, though we think it's possible that
modestly above 3% outsourcing revenue growth is possible for IBM in 2011.
Higher margins: IBM's pre-tax margin on a Y/Y basis increased by 2.2 percentage points in the GTS
unit (likely helped by ongoing productivity gains through better use of tools and workflow practices, plus
we think add-on work could have helped margins) and increased by 3.4 percentage points in the GBS
unit (likely attributable to improved utilization, and ongoing productivity gains through better use of
tools and workflow practices). Excluding the impact of workforce rebalancing charges, pre-tax margin
improved by 0.5 percentage points and 1.5 percentage points for GTS and GBS, respectively.
Investment Conclusion
We have outperform ratings on Sapient, Accenture, Cognizant, and ADP. We have market-perform ratings
on Visa, MasterCard, Paychex, and Infosys. And, we have an underperform rating on CSC.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Highlights
IBM Global Services' results for Q1:11 were mixed, but disappointing overall. This piece explains IT
services industry implications from IBM's report and our follow-up discussion with management.
On the somewhat positive side, overall Global Services revenue growth improved from 2% in Q4:10 to 3%
in Q1:11, and we see indications that add-on work is helping outsourcing revenues.
On the concerning side, IBM's "transactional" services business showed disappointing revenue and
signings growth, in contrast to Accenture's impressively strong growth results. This could cause investors
to question the strength of the demand recovery in the consulting & systems integration market. However,
importantly, we discuss reasons why we argue IBM's consulting & systems integration business is
meaningfully different than Accenture's and the Indian firms' (with our argument supported by Exhibit 1).
And, due to these reasons discussed herein and our other research based reasons to be confident in the
demand of Accenture and the top Indian firms, IBM's latest report is not causing us to question our industry
thesis or estimates. Briefly stated, we see several reasons why IBM's "transactional" services growth
pattern tends to be weaker than Accenture's during major recovery periods.
Also, we see further evidence that the traditional IT outsourcing market has matured (e.g., IBM's
outsourcing backlog declined $0.5 billion Y/Y in CC), and we view this as an ongoing issue for CSC.
Disappointing data points in IBM's "transactional" services category… Government business a drag
In Q1:11, IBM's transactional services revenues grew 6% in US dollars and 3% in constant currency
(CC), showing a modest improvement from 2% (in CC) in the prior quarter. And, transactional services
signings grew -1% in US dollars and -5% (in CC), reflecting substantially deceleration from +9% (in CC)
in the prior quarter. Note: IBM's "transactional" services category includes consulting & systems
integration services. By comparison, Accenture's consulting segment in the February 2011 quarter
achieved revenue growth of 20% and signings growth of 13% (in CC). What happened to IBM?
IBM says its government business was a substantial (and more than expected) drag on its transactional
services growth – i.e., excluding government business, transactional services revenue and signings
growth was around 5% in constant currency (to clarify, weakness in government had more impact on
signings growth than on revenue growth). Note: We believe government/public sector drives
somewhat greater than 15% of IBM Global Services' revenue and a similar mix of 16% for Accenture.
Three months ago, we think IBM was confident that its Global Services revenue would show acceleration
over the next year. Today, we think IBM is less confident about this. And, based on its weak signings in
Q1:11, we think IBM's consulting/systems integration business could decelerate in the near term.
How can IBM's transactional services business be so weak compared to Accenture's consulting business?
IBM did not give answers to this question. But we maintain Accenture's consulting business is experiencing a
decidedly strong demand phase that should last multiple quarters. And, we see several reasons why IBM's
"transactional" services growth pattern tends to be weaker than Accenture's during major recovery periods:
IBM's consulting & systems integration business has a tendency to recover less dramatically than
Accenture's. In Exhibit 1, to support this point, we've compiled consulting segment growth data for IBM
and Accenture (with efforts to exclude the impact of currency, major acquisitions, and segment
classification changes). This exhibit shows that Accenture's consulting segment during 2004 to 2007 (in
the demand recovery period after the bursting of the Internet bubble) showed a faster and more consistent
growth recovery than IBM's consulting/systems integration business. Moreover, it should not be
surprising if Accenture's consulting growth pattern in today's demand recovery proves to be stronger than
IBM's; this has certainly been the case in recent quarters. In other words, Exhibit 1 shows that the
consulting growth patterns of IBM and Accenture can be quite different, particularly during major
recovery periods, and this provides some evidence that lackluster consulting growth at IBM of late
should not cause Accenture's consulting demand to be called into question.
Accenture is better positioned to capitalize on transformational services demand, which we maintain is
central to the demand phase that is now underway in the services industry. In fact, instead of IBM, we
think the consulting arms of the accounting firms are more important competitors for Accenture today,
given the type of consulting now seeing increased demand. Further, we think Accenture is generally
better than IBM at driving add-on consulting revenue from existing clients (i.e., revenue that is not
backlog-driven), plus the current recovery cycle (and clients' increased willingness to invest in
transformational initiatives) is making such add-on consulting business more in demand – with
Accenture likely benefitting more than IBMGS. At the same time, we underscore that these same
positioning differences tend to make IBM's consulting growth more resilient than Accenture's during
periods of macro-shock when demand for add-on business abruptly drops.
IBM has been more focused on profit growth than revenue growth. For instance, IBM can legitimately
argue that it is improving the mix of its services revenues -- i.e., moving toward higher margin services
and toward services that support the growth of IBM's product businesses (e.g., analytics, Smart Planet).
IBM's growth is more wed to emerging countries than Accenture's (and we see structural reasons for
this). And, while IBM's growth from emerging countries is currently strong, it's not currently
contributing a substantial incremental boost to IBMGS' overall growth. In contrast, Accenture's growth
and the top Indian IT services firms' growth rates are more wed to developed countries, where growth is
now generally seeing demand recovery inflection points. Note also that we think Accenture has a future
opportunity to derive more growth from emerging countries.
Traditional IT outsourcing market is mature, though cyclical factors can help
IBM's outsourcing services category experienced growth acceleration from 2% in Q4 to 4% in Q1 (in
constant currency). We would attribute a good portion this improved growth to cyclical factors that
likely helped add-on work and volumes to improve under existing outsourcing contracts
On the secular side, we see further evidence of maturation in the traditional IT outsourcing market,
particularly in developed countries. IBM's outsourcing backlog of $95 billion, after accounting for
currency effect, declined by $0.5 billion over the last year.
On a related note, see our 4/6/2011 research piece, explaining that we think the traditional IT
infrastructure outsourcing market is actually shrinking (see research link – IT Services: Traditional
Infrastructure Outsourcing Market Is Melting, While Cannibalistic RIMO & Cloud Offerings Heat Up).
Data included in this piece, and highlights of additional data points
Exhibit 1 compiles historical data on Accenture's and IBM's consulting revenue growth history. Exhibits 2
& 3 serve as dashboards, conveying IBMGS’ trends in revenue growth, margins, and signings by segment.
And, in Exhibit 4, we calculate IBMGS' backlog erosion.
To highlight additional data points from IBMGS' Q1:11 report:
Overall services signings were below expectations: IBM reported total signings of $10.5 billion (-18%
Y/Y growth), versus Bernstein's forecast of $12.6 billion.
Mixed data points in outsourcing business: IBM's outsourcing-category signings posted Y/Y growth of
-30%, versus +23% in the prior quarter and -8% in the year-ago quarter (in constant currency). We think
IBM's strong signings in Q4 impacted deal flow in Q1. On a more positive note, outsourcing services
revenues showed +4% Y/Y growth, which reflects improvement from +2% achieved in Q4:10 (again, we
think cyclical factors, such as add-on work, helped outsourcing revenue growth). Also, IBM reiterated its
"backlog roll-forward" analysis that suggests its outsourcing business should be able to achieve +3%
growth in 2011 from backlog (i.e., excluding growth that could stem from additional signings). Overall,
given IBM's exposure to the substantially mature IT infrastructure outsourcing market, we do not have
high expectations for IBM's outsourcing signings growth in 2011, though we think it's possible that
modestly above 3% outsourcing revenue growth is possible for IBM in 2011.
Higher margins: IBM's pre-tax margin on a Y/Y basis increased by 2.2 percentage points in the GTS
unit (likely helped by ongoing productivity gains through better use of tools and workflow practices, plus
we think add-on work could have helped margins) and increased by 3.4 percentage points in the GBS
unit (likely attributable to improved utilization, and ongoing productivity gains through better use of
tools and workflow practices). Excluding the impact of workforce rebalancing charges, pre-tax margin
improved by 0.5 percentage points and 1.5 percentage points for GTS and GBS, respectively.
Investment Conclusion
We have outperform ratings on Sapient, Accenture, Cognizant, and ADP. We have market-perform ratings
on Visa, MasterCard, Paychex, and Infosys. And, we have an underperform rating on CSC.
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