Warren Buffett (Trades, Portfolio) surprised Buffett watchers everywhere in 2011 when he bought a $12 billion stake in tech giant IBM (IBM, Financial). At the time, the stake amounted to 5.4% of IBM’s outstanding shares; at various points in the years following, Buffett added to his position.
Buffett’s IBM purchase surprised because Buffett has always acknowledged that while he may be one of the world’s greatest investors he’s nowhere near becoming a tech-savvy investor. At the height of the tech boom in 1998 Buffett told his investors:
“I could spend all my time thinking about technology for the next year and still not be the 100th, 1,000th or even the 10,000th smartest guy in the country in analyzing those businesses. In effect, that's a 7-foot or 8-foot bar that I can't clear. Some people can, but I can't. The fact that there'll be a lot of money made by somebody doesn't bother me really. There's going to be a lot of money made by somebody in cocoa beans. But I don't know anything about 'em."
But this seemed to have changed by 2011 when Buffett bought IBM after being “hit between the eyes” by the advantages the company enjoys in finding and keeping clients. "It's a company that helps IT departments do their job better," he said. "It is a big deal for a big company to change auditors, change law firms," or for IT departments to move away from using IBM, he said. "There is a lot of continuity to it."
Easier than predicted
As it turns out, it has proven easier for companies to switch away from IBM than Buffett initially predicted. Last week the Oracle of Omaha revealed that he had sold one-third of his IBM stake when the share price rose above Berkshire Hathaway’s (BRK.A, Financial)(BRK.B, Financial) purchase price of $170 at the beginning of this year.
Discussing his decision to sell down the position in an interview with CNBC last week, Buffett said, “I don’t value IBM the same way that I did six years ago when I started buying.”‰I’ve revalued it somewhat downward. IBM is a big strong company, but they’ve got big strong competitors, too.”
After 20 straight quarters of revenue decline, the prevalence of IBM’s “big strong competitors” is too evident. In the interview, Buffett went on to say, “I think if you look back at what they were projecting and how they thought the business would develop I would say what they’ve run into is some pretty fierce competitors.”
A day after the CNBC interview, Buffett spoke about the IBM position at Berkshire Hathaway’s annual general meeting in Omaha, Nebraska. Buffett revealed he thought IBM would “do better in the six years that have elapsed than it has.” There’s been no comment as to whether Buffett has continued to divest his IBM stake in the second quarter, but it looks as if he may now try to wind down Berkshire’s entire IBM holding.
Buffett’s core holdings are strictly limited to those businesses with a strong competitive advantage; IBM has proven over the past six years that it has lost that advantage, which may have lost the company the right to remain in Buffett’s portfolio.
How should investors react?
The big question is, how should IBM shareholders respond to this move? Well, one of the reasons cited as being behind Buffett’s decision to enter IBM is his insight into the use of technology at Berkshire’s subsidiary companies.
For example, it is easy for him to see how large too-big-to-fail firms such as Wells Fargo (WFC, Financial), Coca-Cola (KO, Financial) and BNSF integrate IBM into their businesses and rely on the company’s offering. The decision to sell suggests that companies such as these are now looking away from IBM to provide core IT services – bad news for Big Blue which has always touted its strong reputation with the world’s largest companies.
Having said that, IBM’s turnaround is making some progress. The transformation of the business from a hardware interface software company focused on cloud computing, analytics and artificial intelligence is close to inflection point with revenue from these divisions accounting for 43% of overall revenue during the first quarter. These “strategic imperative” operations reported revenue growth of 12% year on year during the first quarter although this growth was entirely wiped out by a 12% decline in IBM’s core business revenues.
If the growth of IBM’s strategic divisions continues at this rate, it’s not difficult to realize that they will soon overtake the company’s core business. At this point, IBM may become an attractive company once again, but Buffett’s decision to sell says more than the figures ever could. Even though IBM’s new business revenues are growing, the company’s reputation may have been damaged for good.
Disclosure:Ă‚ The author owns no share mentioned.
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