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Betting on IBM's Shares

January 24, 2014 | About:
fedezaldua

fedezaldua

1 followers

I became interested into IBM's (IBM) shares ever since Warren Buffett (Trades, Portfolio) bought stock in the company for the first time back in 2011 – and he kept on buying shares to this day. Nevertheless, I never found a price point where I would be interested to buy the company's shares until now. After disappointing fourth quarter results came up, IBM's shares took a plunge (the stock is down by 4% since quarterly results were unveiled) leaving the company at an attractive valuation point for a company which is growing its EPS and buying back shares.

Weak fourth quarter results but business motto should persist

IBM's fourth quarter was indeed disappointing. Results were again weaker than expected as revenue dropped 5% year-over-year (yoy). Despite weak revenues, and thanks to cost cutting initiatives, share buybacks and a lower than anticipated tax rate, net income grew by 6% yoy.

All the above being said, the company remains a software and IT solutions powerhouse that can be trusted by CIO's across the corporate world making it a great Free Cash Flow machine that cares for its shareholders – the company has a strong share buyback plan and keeps on increasing its cash dividend yield - now at around 2%. Besides, IBM's management has reiterated its EPS guidance of $20 in 2015 earnings which makes it an increasingly attractive asset from a price to earnings perspective.

Selling under performing businesses

On the other hand, IBM seems to be focusing in its most promising businesses and is willing to sell those segments that are not compelling from a ROIC standpoint. A great example of this is IBM's recent agreement to sell the company's x86 server business to Lenovo (LNVGY) for approximately $2.3 billion ($2.0 billion in cash and $300 million in Lenovo stock) or 0.5 times 2013 sales. On top of the cash and stock price, around 7,500 IBM employees shall be hired by Lenovo.

Even when the price tag looks low relatively to what IBM initially wanted for its x86 business (around $5 billion), the IT giant is removing from its P&L a business that added no significant synergies and generated a pre tax loss of $37.4 million a year.

On Valuation

From a valuation standpoint the stock looks progressively cheap even when its top line growth has been more and more disappointing. IBM sells for 2014 10 times earnings and 7.8 times EV/EBITDA at a time when the company is growing EPS and its operating cash flow per share. Other IT giants such as Oracle (ORCL) sell for 2014 13 times earnings and 8.8 times EV/EBITDA. Vmware (VMW), a leader in cloud computing and a competitor to IBM in that segment, sells for 2014 27 times earnings and 19 times EV/EBITDA.

Bottom line

The oracle of Omaha might be right once more. IBM's management seems committed to keep on transforming the tech giant from a hardware provider to an IT services company committed to giving back cash to its shareholders. Maybe the shares could go down even further but, for sure, IBM looks like a company any value driven investor should keep on his/her watch list.


Rating: 3.8/5 (22 votes)

Comments

TannorP
TannorP premium member - 5 months ago

Thanks for the article,

Interestingly enough Tilson is short IBM.

He cites

"3) I think International Business Machines Corp. (NYSE:IBM) is a slowly declining business engaging in every trick in the book to mask this fact (which is why I’m short it). Jeff Matthews nails it in this blog post:

IBM, to IBMers, always stood for “I’ve Been Moved,” a reference to the way Big Blue moved employees around the country and around the globe to get experience as they worked their way up the ranks.

To Wall Street, however, IBM could stand for “I’ve Been Manipulated,” because no public company we can think of does a better job of schmoozing Wall Street’s Finest and convincing them that there’s a there there, when in fact the there is not quite as there as it might seem."

Josh Zachariah
Josh Zachariah premium member - 5 months ago

That's very interesting Tilson is short IBM.  But the arguments him and Stan Druckenmiller give are in my opinion terrible.  Druckenmiller described the company as a bet against innovation while Amazon is for it.  The $1 billion in Watson, $2 billion in Softlayer (cloud business), $1.2 billion in data centers for the cloud, $1 billion on flash memory development and billions more in other acquisitions and other R&D really convey they're taking the competition serious and adjusting for the future.

The Systems & Technology revenue has been declining, but that's all part of IBM's plan as they parcel off that declining business piece by piece.  The other businesses except the financing business (which makes sense, companies awash in cash don't need financing) are also growing or at the very worse stagnanting.  Tilson is surely a smart guy, but I'll take Buffett's conviction over his and Druckenmiller's any day 

vgm
Vgm - 5 months ago

Tilson has a very spotty record for shorts, famously shorting Apple when it was in the $100+ range with a typically in-depth thesis :-)

Charlie Bobrinskoy, respected value investor of Ariel funds, talked about his enthusiasm for IBM recently and how he thinks Druckenmiller has it all wrong. IBM discussion starts at 5:15 mins:

http://media.bloomberg.com/bb/avfile/Markets/Analyst_Calls/vRc3tv12cwvY.mp3

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