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Fresh off a stellar quarter that saw strong growth across most of its business, IBM Corp. now faces the challenge of convincing investors that its finely tuned operation isn't running out of expansion room.

Shares of the giant computer-services company climbed 6 per cent this past week after it said revenue increased by 12 per cent and profit rose 8 per cent from the same quarter a year earlier. But several of the analysts covering IBM are not convinced the shares represent a buying opportunity, with some questioning how much more efficiency the company can squeeze out of operations.

For the last eight years, IBM has delivered double-digit annual profit growth, but it has been well over a decade since it has managed to expand its revenue at that rate, notes Brian Marshall, an analyst with Gleacher & Co. in San Francisco. The "massive size of [the] company is a growth impediment," he says.

The risk with IBM is that most of the juice has already been extracted from the company's winning model, Mr. Marshall warns. "Due to management's excellent performance over recent years, one can make a compelling argument that IBM has little 'low-hanging fruit' left to capture and that the company's financial model is close to optimal."

Certainly during the three months ended June 30, IBM looked solid. Sales rose 6 per cent in the United States, despite weak demand from the government sector. But the real engine of growth appeared to be emerging markets, specifically Brazil, Russia, India and China, where sales grew by 21 per cent year-over-year.

IBM beat expectations on the Street, boasting second-quarter profit of $3.7-billion (U.S.) on sales of $26.7-billion. Removing the effect of a weakening U.S. currency, which inflates results of foreign operations, revenue growth would have clocked in at 5 per cent. Growth looked impressive across the company, with software sales jumping 17 per cent, hardware sales expanding by 17 per cent and services – the largest division – advancing by 10 per cent.

The company said it booked significantly more business than had been expected in its services division. Looking ahead, IBM increased its profit forecast for the year to at least $13.25 a share, compared with analysts' consensus view of $13.21 and the company's own previous guidance of $13.15. Amit Daryanani of RBC Dominion Securities called the new targets "modestly conservative."

Under the leadership of chairman and chief executive officer Samuel Palmisano, IBM has earned praise for keeping up with trends in the technology sector at a time when many other players have been caught flat-footed. Over the last few years management has shed lower-margin operations such as PCs and printers and bulked up its services division.

The Armonk, N.Y.-based company's road map for the next few years includes finding growth in the red-hot area of cloud computing, as well as a project called "smarter planet" that aims to bring computing intelligence to power grids and other infrastructure.

With cloud computing, data and applications are stored remotely on a network that users can tap into from anywhere. IBM hopes to capitalize on the trend in two ways. First, it sells powerful hardware for running the data centres that cloud computing requires. Second, it sells services for companies that want to outsource their cloud computing.

Fruitless promises were made a decade ago by companies promoting an earlier version of cloud computing and today the trend is still in its infancy. Obstacles include issues such as security and reliability. "It could be many years until this model of computing reaches mass adoption," Mr. Marshall advises. He has a "neutral" rating on IBM shares and hasn't set a price target.

Some analysts, such as Eyal Ofir of Canaccord Genuity, say IBM's stock is fairly valued. This past week, he raised his price target on the shares to $190, from $180, but continued to rate them "hold," believing that most of the upside from the latest results are already priced in.



What is clear is that IBM is a cash machine, pumping out $3.4-billion (U.S.) in free cash flow during the last quarter. Unlike other leading technology companies, including Apple Inc. and Microsoft Corp., IBM has been forthcoming about what it plans to do with its cash.

Executives have said they expect to spend about $20-billion on acquisitions by 2015, another $20-billion on dividends and $50-billion on share buybacks. In the last quarter alone, IBM spent $4-billion on stock buybacks, reducing the number of outstanding shares by about 1.5 per cent.

RBC's Mr. Daryanani says gaining market share from rivals and tapping emerging market growth will be essential for the company to help offset weak demand from the U.S. government and a slowdown in Western economies.

He thinks the company will generate stronger growth than its main competitor. He values the shares at 14 times projected earnings for the next 12 months and this past week raised his price target to $200 a share, up from $180. He rates the stock "sector perform."

"We continue to recommend IBM for investors who are looking for a relatively safer, defensive investment for a multi-quarter period," he wrote in a research report.

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