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IBM Chapter from the Moats Book

March 25, 2014 | About:
budlab

Bud Labitan

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IBM (IBM) Competitive Advantages

Bud Labitan with Tim Bishop and Peter Stein

IBM is uniquely positioned to profit from global infrastructure growth around the world; and, Warren Buffett (Trades, Portfolio) realized this in 2011. International Business Machines Corporation (IBM) is an information technology (IT) solutions company. The Company operates under five segments: Global Technology Services (GTS), Global Business Services (GBS), Software, Systems and Technology, and Global Financing.

Berkshire Hathaway Inc has accumulated a 5.5 per cent stake in IBM. It is the biggest bet in the technology field he has historically shunned. Berkshire Hathaway Inc. recently bought about 64 million shares of IBM at a cost of $10.7 billion.

With IBM, he invested in a 100-year-old franchise with an impeccably profitable track record. IBM is a business uniquely positioned to profit from global infrastructure growth around the world.

Charlie Munger (Trades, Portfolio) has often said two things about thinking that can apply here: “Invert, always invert” and “Opportunity comes to the prepared mind.” Next, note that Warren Buffett (Trades, Portfolio) said that he has read the IBM annual report every year for 50 years. And, this year he got a different slant on it. He said, “I read it through a different lens… just like I did with the railroads… I don't think there's any company that's—that I can think of, big company, that's done a better job of laying out where they're going to go and then having gone there.”

Buffett said that Lou Gerstner saved the company from bankruptcy. Buffett read Gerstner’s book "Who Said Elephants Can't Dance?" a second time. Then, Buffett “just came away with a different view of the position that IBM holds within IT departments and why they hold it and the stickiness and a whole bunch of things.” Buffett also had praise for Sam Palmisano, IBM’s Chairman and former President.

BUFFETT TO CNBC: “The other thing I would say about IBM, too, is that a few years back, they had 240 million options outstanding. Now they probably are down to about 30 million. They treat their stock with reverence which I find is unusual among big companies. Or they really are thinking about the shareholder.”

Charlie Munger (Trades, Portfolio) has said in the past, “We all are learning, modifying, or destroying ideas all the time. Rapid destruction of your ideas when the time is right is one of the most valuable qualities you can acquire. You must force yourself to consider arguments on the other side.” In IBM and BNSF, Buffett and Munger have shown a willingness to change their views when the facts have changes.

Buffett acknowledged to CNBC that he bought railroads and control of GEICO on market price highs too. Readers should think about the intrinsic value bargains.

BUFFETT TO CNBC: “I look at everything but most things I decide I can't figure out their future. IBM helps IT departments do their job better. We've got dozens and dozens of IT departments at Berkshire. I don't know how they run. I mean, but we went around and asked them and you find out that they very much get working hand in glove with suppliers. And that doesn't mean things won't change but it does mean that there's a lot of continuity to it. And then I think as you go around the world, IBM, in the most recent quarter, reported double-digit gains in 40 countries. Now, I would imagine if you're in some country around the world and you're developing your IT department, you're probably going to feel more comfortable with IBM than with many companies.

BUFFETT TO CNBC: I said I competed with IBM 50 years ago. I was chairman of the board, believe it or not, of a tech company one time, and computers used to use zillions of tab cards and IBM in 1956 or '7 signed a consent decree and they had to get rid of half the capacity. So two friends of mine, one was a lawyer and one was an insurance agent, read the newspaper and they went into the tab card business and I went in with them. And we did a terrific job and built a nice little company. But every time we went into a place to sell them our tab cards at a lower price and with better delivery than IBM, the purchasing agent would say, nobody's ever gotten fired from buying—by buying from IBM. I mean, we probably heard that about a thousand times. That's not as strong now, but I imagine as you go around the world that there are—there's a fair amount of presumption in many places that if you're with IBM, that you stick with them, and that if you haven't been with anybody, you're developing things, that you certainly give them a fair shot at the business. And I think they've done a terrific job of developing that. And if you read their reports—if you read what they wrote five years ago they were going to do and the next five years, they've done it, you know, and now they tell you what they're going to do in the next five years, and as I say, they have this terrific reverence for the shareholder, which I think is very, very important. And I want to give full credit to Lou Gerstner because when he came in, I was a friend of Tom Murphy's and Jim Burke's, and they were on the search committee to find a solution when IBM was almost broke in 1992, and everybody thought they were going pretty far afield when they went to Lou Gerstner.

BUFFETT TO CNBC: Well, you don't have to think of another one, Joe. And if you read his book, you know, "Who Said Elephants Can't Dance?" it's a great management book. Like I said, I read it twice. There were lots of things in that annual report but the truth is, there were probably lots of things in the report a year earlier or two years earlier that you say, why didn't I spot it then? And I think it was Keynes or somebody that said that the problem is not the new ideas, it's escaping from old ones. And, you know, I've had that many times in my life and I plead guilty to it. I will tell you one very smart thing that Thomas Watson Sr. said. I knew Thomas Watson Jr. just a little bit. Tom Watson Sr., this applies to stocks. He said, "I'm no genius but I'm smart in spots and I stay around those spots." And that's terrific advice. "I don't know of any large company that really has been as specific on what they intend to do and how they intend to do it as IBM," Buffett told CNBC in an interview. Buffett said he was convinced by IBM's long-term roadmap and by IBM’s entrenched position with major businesses. This “entrenched position with major businesses” is a big part of the durable competitive advantage that he looks for when investing.

Recently, IBM’s 5Yr Gross Margin (5-Year Avg.) is approximately 44.0% and its 5Yr Net Profit Margin (5-Year Avg.) is approximately 12.3%, while the industry Net Profit Margin (5-Year Avg.) is 11.2%, and the S&P Net Profit Margin (5-Year Avg.) is 11.5%.

IBM customers have a desire to buy professional technology services and products from them. Customers do not want substitutes from less-experiences newcomers handling their important data. Therefore, IBM has a respected brand and pricing power to earn a superior return. Customers know that IBM has a network of able and trustworthy support professionals. So, IBM is uniquely positioned to profit from global infrastructure growth around the world.

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A truly great business must have an enduring “moat” that protects excellent returns on invested capital. -- Warren Buffett (Trades, Portfolio)

How do you compete against a true fanatic? You can only try to build the best possible moat and continuously attempt to widen it. -- Charlie Munger (Trades, Portfolio)


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