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Mark Yu
Mark Yu
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Berkshire Hathaway Has Given Up on IBM, but Recent Acquisition May Resuscitate Big Blue

Is IBM worthy of another shot?

December 04, 2018 | About:

Earlier this year, Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) sold its entire International Business Machines (NYSE:IBM) stake.

After acknowledging his calculations on IBM were flawed in mid-2017, Warren Buffett (Trades, Portfolio) finally directed Berkshire to exit its investment in the company. At its peak investment in the tech company, the conglomerate held somewhere near $12 billion worth of IBM shares.

The Oracle of Omaha’s exit may have brought along the bearish market sentiment on the stock as IBM has fallen nearly 15% year to date.

To its credit, the company has actually beaten analyst revenue and earnings expectations so far this year and only to disappoint by missing approximately $200 million in revenue estimates in the most recent quarter.

IBM also highlighted revenue in its only fast-growing business, cloud, grew an impressive 20% in the last 12 months compared to a year earlier. Nonetheless, overall pretax profits dipped nearly 9% year over year.

These results may have pushed IBM to make the most significant tech acquisition of the year by offering to acquire Red Hat (RHT) for $34 billion.

"The acquisition of Red Hat is a game-changer. It changes everything about the cloud market," Ginni Rometty, IBM chairman, president and CEO, said. "IBM will become the world's #1 hybrid cloud provider, offering companies the only open cloud solution that will unlock the full value of the cloud for their businesses."

The market has yet to be fully convinced since Red Hat shares are still trading about 6% lower at $179 per share compared to the $190 IBM offer as of last Friday.

Offering nearly 75 times Red Hat’s trailing earnings or 26 times its book value is certainly a jump for IBM. The company's last billion-dollar acquisition was $2.6 billion with cloud-based provider Truven Health Analytics in 2016. There was also only one acquisition that IBM spent more than $5 billion; when the company acquired Cognos, a business intelligence company, back in 2008.

To be fair to IBM’s substantial purchase price, Red Hat has averaged 74 times its earnings in the past five years, making the 75 times acquisition somewhat rational.

Red Hat’s revenue represented 4% of IBM’s total business last fiscal year. It certainly will be interesting to see how Red Hat’s solid business growth could help facilitate IBM’s business. The company averaged 17% revenue growth and 11.5% profit growth in the past five years.

Currently trading near its one-year low, along with a 4% dividend yield, IBM should raise some interest in the value investors field. Nonetheless, another famed value investor has just given up on IBM in the recent quarter. The firm Gardner Russo & Gardner, led byTom Russo (Trades, Portfolio), just reduced its stake by a little more than 70% following Berkshire's actions earlier this year.

Despite this consistent bearish sentiment, analysts do expect a near 26% upside on IBM from today’s share price of $125 to at least $156 on average.

One thing is clear, however, not everything Berkshire goes out of results in further disappointing performance over the long term.

As an example, Berkshire liquidated nearly 90% of its investment in Walmart (WMT) back in the fourth quarter of 2016, and the retail giant has returned 47.54%, including dividends, since then.

Disclosure: Long WMT, BRK.B

Correction: Earlier version of the article incorrectly stated that IBM was currently trading at less than its book value. This was corrected to currently trading near its one-year low instead.

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About the author:

Mark Yu
I'm a doctor in physical therapy (DPT) with an interest in finance. Not a registered financial analyst. Value seeker. Long only. Global investing. Long-term investing.

I attempt to dissect one company filing every day. I dislike goodwill and intangible assets.

One company (review) a day keeps the speculation (hopefully) away.

"The only source of knowledge is experience."

"I have no special talent. I am only passionately curious." - Albert Einstein

"To strive, to seek, to find, and not to yield." - Alfred, Lord Tennyson

"We find one a year, that's terrific. You do not need a hundred or a thousand great investment ideas to do well. You need a couple. And, the discipline is the most important thing." - Warren Buffett

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