Blue Revenues For Big Blue’s Client

IBM's computer outsourcing whims cause OAO woes

In business, small companies will always tell you that it helps to have influential friends in high places. But, the minute that same powerful pal does an about-face, it can sometimes spell trouble.

That’s the position Greenbelt, Maryland’s OAO Technology Solutions Inc. (Nasdaq: OAOT) recently found itself in. Its largest customer, IBM, asked for cost cuts from a few of its outsourcing partners earlier this year. It turns out that Big Blue, as IBM is called, often farms out the repair, maintenance and service business to smaller firms like OAO. And for companies like OAO, that’s a godsend. In 1997, IBM-related business contributed 66.2% of OAO’s total revenues of $84.7 million.

IBM’s decisions, including price cuts, elimination of about $1.2 million from a nonrecurring project and shutdown of three smaller IBM projects, jolted OAO’s sales. In fact, revenues from IBM decreased 22% in the first quarter of 1997, from $14.7 million to $11.5 million.

In its May 11 first-quarter earnings report, OAO said that pricing pressure in the IBM Systems Management business will continue to squeeze margins and will sink second-quarter profits as well. The company earned $638,000, or 4 cents per diluted share, in the first quarter, compared with $584,000, or 6 cents per diluted share, in the first quarter of 1997. Per-share results for 1998 were based on a greater number of shares outstanding and were reduced by 2 cents on expenses related to OAO entering a new line of business.

“I think that going forward OAO will work to cut its own costs and bring in new, higher-margin business,” said analyst Joseph W. Garner of the Lancaster, Pennsylvania, firm Emerald Research. On May 12, however, the analyst cut his short-term rating on OAO shares from “buy” to “neutral,” and his long-term rating from “strong buy” to “buy.” He also lowered his 1998 earnings estimate from 23 cents a share to 14 cents, and his 1999 view from 36 cents to 28 cents. Garner says OAO shares, which traded as high as $11.88 in February and then sank to $4.38 in June, should reach $8.50 a share in the next year or so.

The reason for such guarded optimism is the fact that OAO is fishing for new clients besides IBM. For one, Digital Equipment, another computer giant that contributed 24% of the company’s revenues, was recently taken over by Compaq, but has remained an eager customer. Meanwhile OAO is pursuing strategic alliances with computer industry players such as NCR Corp. and Oracle.

OAO is also developing software megaplexes that will help corporate customers maintain and expand their computer systems’ capabilities. At the same time, OAO’s push to become more independent of its customers’ whims has been bolstered by key acquisitions. One major step was the April acquisition of a software developer and information technology services firm with a client base in the healthcare, insurance and mortgage industries.








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