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IBM Expands in Brazil

Consistent with its expansion policy in the growth markets, tech giant International Business Machines Corp. (IBM) recently announced its entry into a strategic agreement with Brazil-based EBX Group. EBX Group headed by Brazilian billionaire Eika Batista comprises eleven companies with operations in diversified fields such as logistics, energy, marine, entertainment, mining, oil & gas and technology.

As per the terms of the agreement, IBM will acquire 20% of SIX Automacao, a subsidiary of SIX Solucoes Inteligentes, the technology arm of the EBX Group. Moreover, IBM will set up a research & development (R&D) center in collaboration with SIX Automacao, which will focus on developing technology solutions aimed at boosting EBX’s presence in the natural resources and infrastructure sector in Latin America.

EBX expects to invest approximately $50.0 billion in Brazil over the next 10 years, which presents significant growth potential for IBM in our view. To focus on its core business, EBX outsourced its IT operations to IBM, which will add approximately $1 billion to the company’s cash coffers over the next ten years. Since, the outsourcing contract covers EBX’s domestic as well as international companies in Latin America, we believe that this presents an immense opportunity for IBM to expand its operations in the other emerging economies of Latin America such as Chile, Colombia and Peru.

According to BBVA Research, Peru, Colombia and Panama are expected to register highest economic growth during the period 2012-2015. Although Brazil’s economy is currently expected to face tough times in 2012, rating agency Fitch notes that the country is expected grow at a steady pace, driven by structural reforms such as privatizations and trade liberalization. According to an Indian newspaper “The Times of India”, Brazil is poised to become the sixth biggest nation in terms of gross domestic product (GDP) by 2020, just behind China, India and Russia.

As a part of its growth policy, IBM opened a global research lab in Sao Paulo and Rio de Janeiro in 2010. In 2011, IBM conducted a SmartCamp (a compnay initiative that helps start-up entrepreneurs to reach venture capitalists) along with the Venture Capital Symposium in Brazil. IBM also opened a micro-financing center in Lima, Peru during 2011.

Recently, IBM announced that it has invested approximately $22.85 million to launch its first corporate public cloud in the country. This initiatives boosted IBM’s top-line growth in Latin America, which increased 17% year-over-year in 2011. Brazil posted a 13.0% year-over-year increase in revenues. We believe that IBM will continue pursue strategic acquisitions and partnerships in the Latin American region, which will boost its growth over the long term.

IBM and Growth Markets

Emerging economies (termed as growth markets by IBM) forms an important pillar of IBM’s long term growth strategy. Over the last decade (2000-2010), the company has focused on expanding its operations in emerging growth economies of the Asia-Pacific, Africa and Latin America. During the period, IBM earned more than $10.0 billion from growth markets which contributed approximately 21% of total geographical revenue.

In 2011, growth markets contributed 16.0% of geographic revenue versus a 5.0% contribution from major markets. These growth markets generated approximately half of IBM’s geographic gross profit growth. IBM has significant exposure to the BRICS (Brazil, Russia, India, China and South Africa) countries, which contributed 19% of its revenue in 2011.

In order to further diversify its revenue base, IBM is expanding its operations beyond the BRICS countries. The company has opened nearly 100 new branch offices in non-BRICS regions during 2011. The company has also opened data centers, banking centers and research facilities in a number of African countries as well as in Singapore, Japan, Korea, Hong Kong and Vietnam.

Moreover, IBM is also targeting the academic segment through relationships with a number of universities for imparting information technology training to students, thereby boosting its socio-economic relevance in these regions.

IBM expects these markets to contribute approximately 30.0% of its revenue over the next five years (2011-2015). Further, the company expects these markets to contribute 50.0% of its growth over the next five years. Smarter planet, business analytics and cloud initiatives are expected to fuel the growth. In such a scenario, we believe that the agreement with EBX bodes well for IBM as it will spur growth possibilities in the Latin American region going forward.

Our Take

Although we remain optimistic with IBM’s policy of expanding its business in the Latin American region particularly Brazil, we remain concerned about the increasing government regulation for U.S.-based companies going forward. IBM, along with other U.S. based companies face tax related issues in Brazil, which may become an impediment for growth in this region going forward.

However, as growth and investment opportunities in the developed countries slow down in 2012 and beyond (the visibility is considerably murkier), we believe that emerging economies of Africa, Latin America and the Asia-Pacific will play a key role for IBM. We also believe that IBM’s continued focus on global expansion will provide it a significant competitive edge over its rivals including U.S. companies such as Amazon Inc. (AMZN), Microsoft Corp. (MSFT) and Google Inc. (GOOG) as well as smaller local companies operating in any given region.

We have a long-term Neutral recommendation on the stock. Currently, IBM retains a Zacks #3 Rank, which implies a short-term Hold rating.

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