As one of the oldest technology companies in the world, International Business Machines (IBM, Financial) still strives to innovate and meet its clients' changing information technology needs. The company primarily sells software, IT services, consulting and hardware. It operates in 175 countries and employs approximately 270,000 people. The company has a roster of 80,000 business partners to service 5,200 clients, which includes 95% of all Fortune 500 companies.
IBM's future growth hinges on a diverse collection of hybrid cloud, technology infrastructure and consulting-related products and services. The slower growth legacy operations of managed infrastructure services and related consulting was spun off into a separate company in November 2021, now called Kyndryl (KD, Financial). The remaining business is now being largely driven by the revenue growth for Red Hat, which was acquired for $34 billion in 2019. This segment will likely rely on additional acquisitions, particularly in the cloud space.
Kyndryl spinoff
On Nov. 3, 2021, IBM distributed 80.1% of its interest in Kyndryl to holders of its common stock. Holders of IBM common stock received one share of Kyndryl common stock for every five shares of IBM common stock held as of the close of business on the record date, Oct. 25, 2021.
This spinoff allows IBM to focus on its higher-growth cloud-related businesses without being dragged down by the slowing growth of legacy operations.
Financial results
The company’s financials have been restated to account for the Kyndryl spinoff. The 2021 restated results show revenue growth of 3.9% for the year and a gross profit increase of 2.0%. Net income from continuing operations increased 19.8% and EPS from continuing operations increased 18.9%.
In the fourth quarter, strength was evident in the software segment with 10.1% constant currency revenue growth. Within that segment, Red Hat revenues increased 21% and hybrid cloud revenues increased 24%. The overall consulting business also looked strong with 15.7% constant currency revenue growth.
The company continues to spend about 10% to 11% of revenues on research and development, with last year's R&D spending to the tune of about $6.5 billion. Although the payoffs from much of these investments are years or decades away, IBM is known for its innovative research leadership in areas such as quantum computing, artificial intelligence and blockchain technology.
Balance sheet and liquidity
IBM ended the 2021 fiscal year with $7.6 billion of cash marketable securities, which was down $6.7 billion from year-end 2020, reflecting acquisitions of $3.3 billion and debt reduction efforts. Total debt, including financing debt of $13.9 billion, was $51.7 billion, down $9.6 billion since the end of 2020, and down more than $21 billion since closing the Red Hat acquisition. The company returned $5.9 billion to shareholders in the form of dividends.
Valuation
Revised estimated earnings call for earnings per share of approximately $9.86 in 2022 and $10.54 for 2023. That implies the company is selling for only 12.7 times 2022 earnings estimates and 12.0 times 2023 earnings estimates. Due to the company’s still-high debt levels, IBM's forward enterprise-value-to-Ebitda ratio is 10.5 using 2022 estimates.
IBM is paying an annualized dividend of $6.56, which equates to an above-market dividend yield of 5.2%.
Guru trades
Gurus who have added to their IBM positions recently include Mario Gabelli (Trades, Portfolio) and Joel Greenblatt (Trades, Portfolio). Gurus who have reduced their positions include Ken Fisher (Trades, Portfolio) and Dodge & Cox.
Conclusion
I believe IBM is undervalued at this time relative to its expected growth rates going forward. The low forward price-earnings ratios combined with an above-average dividend creates a margin of safety for investors.
