IBM's Watson – From Jeopardy to Middleware Software Upside

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IBM ( IBM ) competes with Oracle ( ORCL ) and Red Hat in the middleware software market.

IBM's advanced computing device Watson, "designed to quickly answer complex questions with pinpoint precision", recently defeated human competitors on the popular TV show Jeopardy. Watson, developed by IBM's scientists over the last three years and named after IBM's founder Thomas J. Watson, Sr., has taken data analysis capabilities to a new level.

According to IBM, "The computing engine (used in Watson) is much more than a simple Web search engine" and "understands the nuances of 'natural language' that humans use every day". Watson "does not just search on keywords, but actually understands idiomatic expressions, puns, linguistics and can parse clues and come up with answers".

Watson incorporates open technologies such as UIMA (Unstructured Information Management Architecture), Eclipse, and Apache Hadoop and is powered by IBM POWER7 processor,  which is specifically designed to meet the demands of workloads like IBM's DeepQA natural language processing technology. Watson's success is attributed to both its advanced processing capabilities (hardware) as well as its efficient algorithms for information management (software). We believe that this type of technological advancement puts IBM in a position for upside over the long-term.

It is the software advancements achieved during the development of Watson that will be most beneficial to IBM, rather than the addition of new and more  powerful POWER7 processors to its portfolio. We estimate that IBM derives nearly 46% of its value through its middleware software offerings to businesses around the globe, while server sales contribute a mere 3% to our $185 price estimate for IBM's stock . Our price estimate stands roughly 10% ahead of market price.

See our full analysis and $185 price estimate for IBM

Upside for IBM's Middleware Software Business

Middleware is a type of software "plumbing" used to connect different software applications that need to share information.  Middleware is commonly used by businesses that have a variety of separate software systems to make information integration easier.  By making it easier to integrate and share information, businesses can work more efficiently and better serve customers.

IBM has a variety of middleware products with brands like Websphere, Lotus, Tivoli and Rational that are used to connect different types of software systems. IBM is a leader in the middleware business with a nearly 50% market share.

With advancements in its data analysis and information management software capabilities, as displayed by Watson on Jeopardy, IBM can further extend its dominance in the middleware software market against competitors like Oracle and Red Hat. A pickup in IBM's middleware license revenues as a result of improved software capabilities going forward could result in significant upside to IBM's stock value.

We currently estimate that IBM's middleware license revenues will increase from roughly $5.5 billion in 2010 to $10.3 billion in 2017. However, if IBM can capture greater market share due to software advancements, and middleware license revenues accelerate towards $14 billion (vs. our $10.3 billion base estimate), there could be over 10% upside to our $185 price estimate for IBM's stock .

Drag the trend line in the interactive chart above to see the affect of various middleware license revenue scenarios on IBM's stock value.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: IBM , ORCL

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