IBM is the next big Internet stock

Internet mania is everywhere--in the news, in schools, at the workplace, and nowhere more evident than in the stock market. Many of the pure-play Internet companies have extraordinary valuations, pushed even higher recently with the belief that typical holiday buying madness will benefit on-line retailing.

Many of the stories behind these Internet stocks are compelling, but as an investment analyst, I typically look for ways to play a theme that are more elusive, where the upside is not already baked into the stock's valuation, and hence the risk of downside disappointment is minimized. And looking at the Internet, I believe a company that fits this description is--believe it or not--IBM.

IBM is big, and its products and services address almost all segments of the technology landscape. The company is traditionally thought of as the dominant supplier of products to the data center--that place in each company that is the heart and soul of its computing infrastructure, and run by traditionally risk-averse managers, the last people one would think to embrace Internet technologies.

So why IBM? First, the trends behind the Internet, from its super-rapid expansion, incredible complexity, and migration from information transfer to e-commerce all flow right into the strengths of IBM.

IBM is the hands-down leader in large, mainframe-class computers--the ultimate in scalability. Already many high-traffic Internet sites have been compelled to migrate to this platform, as other technologies and vendors couldn't provide the capacity. I think this will only continue--by all accounts, the Internet is growing faster than the growth in power of smaller-scale computing platforms.

Second, the next big growth wave for the Internet, I believe, will be business-to-business transactions. Much has been written about this subject (even in this column) so I will not explore this evolution--but I'm convinced it is inevitable. But I will point out that IBM has been solving this type of problem for its customers for decades--it is No. 1 in transaction processing software, and No. 1 in secure systems--both areas which will be critical to the next wave of Internet growth. IBM's technology investment in the past is giving them a jump-start toward the Internet of the future.

Third, technology managers are becoming less risk averse, and CEOs and CIOs are aggressively embracing Internet strategies. Management teams everywhere have seen what Amazon.com has done to the book retailing business, and are afraid that the same could happen in their industry. And those that have embraced e-commerce in any way are quickly understanding the mission-critical nature of their web sites--as they move from the "Isn't it cute?" stage to "It better work."

Finally, IBM is focused on the Internet. E-business not only is the center-point of the company's widely-seen advertising campaign, but it is the rallying cry for employees internally. E-business has tied together many of IBM's disparate systems, has given their dominant Global Services organization a new avenue for growth, and has allowed IBM to focus its wealth of technical competence and innovation on solving a major new customer problem.

Meanwhile, other parts of IBM are running smoothly. IBM's mainframe business has improved due to a new product cycle, its PC business has strengthened both in the commercial and consumer segments, and its services segment continues to grow more than 20 percent year-over-year. I am extremely comfortable that the company will meet or beat my current fourth quarter earnings per share estimate of $2.45, on $25.9 billion in sales.

Like other Internet-related stocks, IBM (December 3 closing price, 163.5) has had solid performance over the past few months. And although the company is not a pure play, and because of its size, it will likely grow revenue between 10 to 15 percent over the next few years. Additionally, its price-to-earnings multiple (currently 22 times our 1999 earnings per share estimate) is significantly lower than either comparable companies, or the S&P 500 Index average. I currently rate the stock a "strong buy".

Philip Rueppel is a research analyst with BT Alex. Brown Incorporated. This column is not a publication of BT Alex. Brown and may not represent Rueppel's complete or current opinion with respect to any company. Persons who want to make an investment decision with respect to any company mentioned by Rueppel should obtain a copy of Rueppel's current and complete opinion as contained in the most recent publication of BT Alex. Brown Incorporated. Rueppel's opinions are not intended as an offer or solicitation, nor as the basis for any contract for the purchase or sale of any security, loan or other instrument.