International Business Machines (IBM, Financial) recently released their quarterly results; let us take a closer look at how things are faring for the IT bigwig.
IBM earnings numbers
The common practice followed in the market is that companies release their earnings numbers before the bell if the news is good, giving the market a reason to buy in, or after the bell if the news is bad, giving the market time to reconsider before possible mass selloff. Therefore, many called the move of IBM announcing results before the starting bells as lunacy. But an opportunist like me would cash in on this either way.
What changed for IBM over the last couple of days was a massive scale down finally coming to terms with Global Foundries for a sale of IBM Microelectronics to the former AMD manufacturing division now owned by Abu Dhabi. The chipset manufacturing division of IBM has been reeling under pressure since it lost the Sony PlayStation chipmaking contract and an antiquated facility in Vermont became virtually defunct. Hence, IBM has now decided to sell off the unit along with all its employees and associated IP to Global Foundries along with $1.5 billion in cash over the next three years. That’s a wise move from IBM, and once it takes shape, IBM will get rid of a considerable wound from its books of business. But as it goes, time is the best healer, hence, so we will have to wait until the whole thing goes through. But the market has still not judged this as positive news resulting in heavy selloffs of IBM shares in the secondary market.
Market buzz about IBM future
The market has made a three-pointer speculation from the earnings report. First, the 2015 earnings target of $20 per share looks far from a reality affair which I fully agree with going by the current number mix of IBM’s book of business.
Second, the current profit counters did not find much contribution from IBM’s new found area of expertise – cloud computing, Big Data analytics and mobile applications. This is true in the current phase of situations, but if we are to look at a period of the next five years, the whole computing system will shift lanes from machine and localized server setup to more efficient cloud setup. Big Data will play a major role in driving retail business and business model changes through predictive analysis and structured and unstructured data interpretation. Hence, IBM has stepped into the domain at the right time. With the launch of the whole new range of smartphones which are reducing the gaps between tablets and phones, mobile applications are bound to gain ground in the future, adding value to IBM’s move into the mobile apps domain. All in all, you have to give the time required to generate quality earnings. The obvious eyebrow-raising argument of the market would be that there are already a large number of names in this arena. But we can't forget the way IBM changed the face of the corporate world with its PCs and servers, and IBM has what it takes to work out its own niche in the competitive atmosphere.
Last, the chip manufacturing unit selloff is regarded as rather negative since it would mean that the power server business would suffer from competition. This part has got a different perceptional view and all the perceptions have got a degree of validity. According to the market buzz, this move will make IBM weak in front of chipset giants like Intel (INTC, Financial) resulting in loss of business in the server domain to Intel.Ă‚
IBM announced this month the launch of new families of Power8 servers with optional Graphical Processing Units (GPUs) that the company considers as a weapon against the kind of Intel-based servers IBM used to make. With this move, IBM was slated to take back the business from Intel. But with the chip unit sale and $1.5 million going in cash to Global Foundries, the chip price does not look to get a competitive price tag. But more often than usual, outsourcing has proven more cost effective than in-house manufacturing in such cases.
Since the selloff of Lenovo’s (LNVGY, Financial) server business, IBM servers have become overly dependent on Power8 processors. IBM is selling it off as well, but something that is yet not clear is the terms of agreement between IBM and Global Foundries acquaintance in terms of buying Power8 chips from the latter. Market assumptions are IBM would buy one million Power8 processors per year from Global Foundries and pay the price of the chips, plus $500 million per year in cash for the next three years, that would add $500 as burden to the real cost of every chip. Because of this, the IBM servers cannot be as competitively priced as the Intel boxes. This is true but only till the next three years, post which they can actually see a better margin generation. Something which seems obviously probable here is that the IBM servers would have to develop something more than just a data center to get a USP to sell them against the cheaper options. This would call in for IBM to think on the lines of empowering its servers with big data analytic features to generate the extra mileage to sell.
A lot of steam still left in IBM
Though poor results have made their share prices take a dip, there has not been a catastrophic sale. Going by the market buzz, IBM has lost all its cards, but if that was true, then there should have been a selloff frenzy triggered. But as I had pointed out earlier, to reap benefits in IBM, patience is key.
IBM has a legacy of generating earnings increase through share buyback and other financial architectures. It’s hard to advise selling shares as long as IBM is capable of these financial moves. Therefore, patience is the best way to work through investments in IBM.
The other reason why Wall Street is loath to call for selling IBM is because the analytics tribe is tied to IBM’s financial services and those services are worth billions. Even Fidelity would probably not sell IBM as long as they are supported by IBM financial services like pension distributions, etc.
Using the Michael Lewis’ rule, “never go against your market sector,” IBM should be a hold for the right time to come but never a sell, even though it probably would have, had it not been for IBM.
Final word
To reiterate my previous words, patience is key. Considering the vastness IBM's operation worldwide, any downside in IBM can be offset by the proceeds from other sectors of business functions of IBM. Also the upside momentum will obviously be slow owing to the same fact. Hence, the best investors in IBM are those who look for value addition with time. The kind of constant evolution that IBM is driving in the IT world says one thing about the company: that it has a futuristic vision and is striving to achieve it through definite ways and means. Its strong foray in the big data and cloud arena will certainly benefit the company’s number mix in the long run, since that is where the future of computing is walking into. So how do we react momentary bad news and its effects? The answer is simple: use it as an opportunity to buy in and add positions in the company and wait for a relatively long term period to reap the yield of what you are sowing today.
