IBM: Intriguingly Boring Mergers

OCTOBER 7, 2011    THE WALL STREET JOURNAL

By ROLFE WINKLER

Boring deals tend to be better deals. That's the tip Hewlett-Packard should take fromInternational Business Machines' latest acquisition.

On Tuesday, IBM bought little-known Q1 Labs, a small, privately-held security software specialist, for an undisclosed price.

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Not surprisingly, the deal failed to excite. Acquisitions like H-P's $10 billion blowout buy of Autonomy get far more attention. They also tend to be worse for shareholders.

Contrast that with IBM's stated strategy to spend $20 billion total on acquisitions from this year thru 2015. What sets IBM's dealmakers apart is their discipline. They target small companies that will benefit from being plugged into IBM's massive, worldwide distribution network. They also look for compelling technology that fits with their existing products.

The strategy seems to have worked well. IBM's return on capital, which measures total operating profit after taxes relative to total debt and equity invested in its business, has averaged a healthy 16% since 2000, according to CapitalIQ data. Over the same period, H-P's return on capital has averaged 9%. It makes sense that IBM would have higher returns given its greater emphasis on high-margin software. Yet the fact that its returns continue to grow suggests the company's acquisition strategy is creating value for shareholders.

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H-P has at times followed the acquisition script successfully. At 3Par, which H-P acquired in 2010, revenue grew in the triple digits in the second quarter compared with the prior year, according to an H-P spokesman. But the Autonomy deal doesn't offer the same potential benefits. Autonomy is already sizable, with revenues estimated at $1.1 billion in 2011. And while its technology is interesting, H-P doesn't have a strong distribution platform for software like it has for hardware. That could limit H-P's returns from the deal.

H-P has destroyed value in the past. It acquired Compaq for $17.3 billion, net of debt and cash. Yet today analyst Toni Sacconaghi of Sanford C. Bernstein estimates its whole PC business is worth less than $12 billion.

When it comes to Q1 Labs, it may be hard for IBM shareholders to get excited. And that's why they should be.

Write to Rolfe Winkler at rolfe.winkler@wsj.com