IBM - International Business Machines

[Palantir]

I'd rather not debate the theoretical value of buybacks, at least on this thread...can we focus on the issue at hand - IBM? I only brought up criticism of buybacks because the response to any dissenting opinion of IBM has been "but they're growing EPS and buying back stock!". If IBM's business is going to struggle in the future, then their IV is a lot lower than management thinks, which would make repurchases a poor decision, so "buying back stock and increasing EPS" may not be the solution.

[obtuse_investor]

Microsoft had a monopoly so maybe not the best comparison.

 

I think the statement of letting my knowledge of a company "cloud" my judgement is just absurd!  Think about what you are saying.  I am a big believer in bottom-up research, where possible and that is what I am talking about when I discuss the quality of their offerings.  To just throw that away as insignificant just makes no sense.  That is how you end up holding a stock like blackberry.

 

 

Sorry no_free_lunch, I seem to have missed this response. I didn't get any email notifications from the board last couple days. Anyway...

 

I get what you are saying. More knowledge about the business must be a good thing. What I am saying is that expert knowledge about the product or service, in this case, software/hardware is well and good; but it doesn't translate to a good prediction of financial sales.

 

What I fail miserably at is when I extend that software knowledge to the financial performance of the business. Maybe it is just me. I am a horrible judge of what software will sell well. Maybe this is because I am not the demographic they are selling the software to. They are selling these things to business school trained managers who need help printing their emails when they aren't making major enterprise software purchase decisions.

 

Anyway, I didn't mean to offend you. If you are good at correctly incorporating knowledge from different fields, all the power to you.

 

My 2 cents.

[mcliu]

I'd rather not debate the theoretical value of buybacks, at least on this thread...can we focus on the issue at hand - IBM? I only brought up criticism of buybacks because the response to any dissenting opinion of IBM has been "but they're growing EPS and buying back stock!". If IBM's business is going to struggle in the future, then their IV is a lot lower than management thinks, which would make repurchases a poor decision, so "buying back stock and increasing EPS" may not be the solution.

 

I don't think there's anything to debate about.. I mean, the math is what it is.

 

Regarding IBM, the way I look at it is:

1) Will the company be around in 20 years? Yes.

2) Has the company struggled in the past? Yes, many times.

3) Did the company overcome its struggles to get to where it is today? Yes.

4) Is it more likely than not that it will overcome its current struggles in the future? Probably, given its track record.

5) Assuming 1 to 4 is true, is the company likely to be bigger or smaller in 20 years? Probably bigger.

6) Will there be more or less shares outstanding in 20 years? Probably less.

7) Assuming 1 to 6, will I end up with a bigger slice of a bigger pie? Probably more likely than not.

[Palantir]

Sigh, let me know when you can make a case for why IBM is undervalued and estimate a figure instead of listing a string of assumptions.

[obtuse_investor]

I guess the question is, does IBM have a moat?

 

IBM is one of Buffett's "big four", he pays a fair price for the big moat businesses that grow forever. His focus on buybacks is misleading and isn't the complete picture. Buybacks are meaningless if there isn't a large moat business that IBM can reinvest into.

 

I would assume that Buffett being Buffett would look at the moat part of the picture first before committing large amount of Berkshire capital into it.

[fareastwarriors]

IBM Uses Dutch Tax Haven to Boost Profits as Sales Slide

 

 

http://www.bloomberg.com/news/2014-02-03/ibm-uses-dutch-tax-haven-to-boost-profits-as-sales-slide.html

[Palantir]

I think all 200B firms have a moat of some sort or another. Question is, how much is it worth? I expect their moat to shrink as we head into the cloud era. Cloud is a scale business and IBM is behind, and I don't think its business model will stand up vs pure integrators.

 

Their services business has a moat due to switching costs, but basically it is an outsourcing shop, making it like other IT firms...

[frommi]

That moat you mean is mostly brand value, you can look up the top100 here: http://www.interbrand.com/de/best-global-brands/2013/Best-Global-Brands-2013-Brand-View.aspx

[Guest valueInv]

Sigh, let me know when you can make a case for why IBM is undervalued and estimate a figure instead of listing a string of assumptions.

 

Why don't you tell us your estimate of IBM's worth?

[Kraven]

Interesting post from Jeff Matthews.  http://jeffmatthewsisnotmakingthisup.blogspot.com/2014/02/ibm-39-emerson-electric-2.html

 

Looks like IBM shaves some of its tax bill by funneling things through a subsidiary in the Netherlands that less than 2% of their workforce is actually at.  I find it fascinating though that when a company like EBIX does this it's probably fraud, but when IBM does it it's just good business.  Some interesting points about Buffett as well.

[Palantir]

11% tax rate is the only reason IBM's earnings went up this year. Given that management's compensation is based on EPS numbers, I am very shocked that they are doing this! I bet their buyback program is also unrelated to this.

 

So much for the moving from low margin to high margin mantra.

[jwfm1985]

11% tax rate is the only reason IBM's earnings went up this year. Given that management's compensation is based on EPS numbers, I am very shocked that they are doing this! I bet their buyback program is also unrelated to this.

 

So much for the moving from low margin to high margin mantra.

 

Management didn't take their bonus this year...

[Palantir]

^You think they'll give up their bonus in 2015?

[Guest valueInv]

Interesting post from Jeff Matthews.  http://jeffmatthewsisnotmakingthisup.blogspot.com/2014/02/ibm-39-emerson-electric-2.html

 

Looks like IBM shaves some of its tax bill by funneling things through a subsidiary in the Netherlands that less than 2% of their workforce is actually at.  I find it fascinating though that when a company like EBIX does this it's probably fraud, but when IBM does it it's just good business.  Some interesting points about Buffett as well.

 

Most companies do this including Apple and Google.

[Kraven]

Interesting post from Jeff Matthews.  http://jeffmatthewsisnotmakingthisup.blogspot.com/2014/02/ibm-39-emerson-electric-2.html

 

Looks like IBM shaves some of its tax bill by funneling things through a subsidiary in the Netherlands that less than 2% of their workforce is actually at.  I find it fascinating though that when a company like EBIX does this it's probably fraud, but when IBM does it it's just good business.  Some interesting points about Buffett as well.

 

Most companies do this including Apple and Google.

 

Not most, some.  My point was more that there is a double standard to it.  When "respected" companies do it no one thinks twice, but on the EBIX thread everyone cried foul.  I have no idea what the mechanics or procedures of anyone doing it are.  It's clearly been blessed by tax counsel.  But as they say, what's good for the goose . . .

[jwfm1985]

^You think they'll give up their bonus in 2015?

 

If performance is below expectations, yes.

[fareastwarriors]

 

IBM explores sale of semiconductor business

 

http://www.reuters.com/article/2014/02/07/us-ibm-semiconductor-sale-idUSBREA1604Y20140207

[physdude]

Interesting post from Jeff Matthews.  http://jeffmatthewsisnotmakingthisup.blogspot.com/2014/02/ibm-39-emerson-electric-2.html

 

Looks like IBM shaves some of its tax bill by funneling things through a subsidiary in the Netherlands that less than 2% of their workforce is actually at.  I find it fascinating though that when a company like EBIX does this it's probably fraud, but when IBM does it it's just good business.  Some interesting points about Buffett as well.

 

Most companies do this including Apple and Google.

 

EBIX has definitely got the short end of the stick. It seems to be one of the stocks being attacked using innuendo and deceptive "misunderstandings" (essentially good propaganda) like Fairfax once was and QCOR and NQ are now. These can make for incredible investments if you can stomach the volatility but it isn't very nice for the managers or employees.

 

Not most, some.  My point was more that there is a double standard to it.  When "respected" companies do it no one thinks twice, but on the EBIX thread everyone cried foul.  I have no idea what the mechanics or procedures of anyone doing it are.  It's clearly been blessed by tax counsel.  But as they say, what's good for the goose . . .

 

[Palantir]

In its quest for $20 a share, IBM sheds jobs

http://gigaom.com/2014/02/14/in-its-quest-for-20-per-share-ibm-sheds-jobs/

[LowIQinvestor]

IBM CEO speaking at Mobile World Congress right now.

 

http://www.mobileworldlive.com/

 

Watson is fascinating to me. Lots of innovation at IBM!

[nikhil25]

IBM laying off up to 25 percent of 'hardware' division

Big Blue confirms it's commencing workforce cuts, but declines to put a number on the job losses. A source tells CNET the layoffs entail up to 25 percent in the Systems and Technology group.

http://news.cnet.com/8301-1001_3-57619685-92/ibm-laying-off-up-to-25-percent-of-hardware-division/

 

 

[Phaceliacapital]

I think all 200B firms have a moat of some sort or another. Question is, how much is it worth? I expect their moat to shrink as we head into the cloud era. Cloud is a scale business and IBM is behind, and I don't think its business model will stand up vs pure integrators.

 

Their services business has a moat due to switching costs, but basically it is an outsourcing shop, making it like other IT firms...

 

I went through the thread and I think we would all benefit if our discussion focuses on "Does IBM have a moat", and if yes "How stable is it" which will inevitably lead to "how much is it worth?". Like mentioned (many) times before, IV is one of the most subjective values in the world (thankfully, otherwise we wouldn't really have a market). Personally, I use a 12% cost of my capital in every valuation that I make, so people using 11% or 13% will (normally) arrive at a different IV.

 

Let's say I think IBM shares are worth 200, and management buys back at 180, this is accretive for me. If I think they're worth 160 and they're still buying back at 180, it's not accretive anymore.

 

To focus on the IBM story (as I am rather new to the company) we have a company operating 3 separate  businesses: Services, software and hardware (and a little bit of financing):

 

• Global Technology Services: Provides IT infrastructure services and business process services. Accounts for 38.8% of sales, 30.4% of pretax income.

• Global Business Services: Provides professional services and application management services. Accounts for 18.5% of sales, 14% of operating income.

• Software: Provides middleware and operating systems software. Accounts for 26.1% of sales, 48.4% of operating income.

• Systems and Technology: Provides advanced computing and storage capability solutions. Accounts for 14.5% of sales, -2.2% of operating income.

• Global Financing: Provides financing to customers. 2% of sales, 9.5% of operating income.

 

 

 

These numbers are as of 2013 and are a clear result of the transformation IBM has gone through when it decided to focus on its services and software divisions. If you plot the segment revenues over time ( 10 yr) you can clearly see the increased importance of services & software, a small decrease in financing (which I haven't looked at in depth) and a strong reduced significance of the systems and technology business. I know, I didn't write anything new but I always like to know where a company has come from. When you read about IBM (it's also mentioned in this thread) it's often mentioned that they have been successfully navigating through ITurbelent waters for the past X years.

 

Is this a guarantee for future navigation? No, but I do prefer a company that has already shown it is capable to adapt...

 

Looking at where the company is today I see 1) negative top line growth in recent years, 2) stable gross profit, ebitda and net income margins 3) over the years a strong increase in FCF (corrected for business acq) per share but a declining FCF (CFO - capex - net business acquisitions) yield (around 4.95%).

 

At first sight, a 4.95% FCF yield is not necessarily "cheap". The question we as possible owners have to answer is:

 

1) What is a normalized FCF going forward?

 

Concerning capex, if I look at 12 years of financials (capex + net business acquisitions)/CFO has an average of 42%.  The question is then, can we as business owners believe that going forward, IBM will no longer need the growth capex "hidden" in the investing activities line?

 

I don't know the industry as well as I should to answer that question, but I would currently put my money on no, they do need the growth capex. I think this is also logical right? They're facing increased competition from "the cloud" and the whole SaaS development. Unless they have purchased all the companies they need to face this kind of competition in the past years, we can't really expect growth capex to decrease?

 

Historically,  (capex + NBA) = 6.7 bn. If we assume it stays around this level FCF can only grow if CFO grows.

 

Second question, is CFO growing? As of 2013, it wasn't really growing (17.5 vs 19 .5 in 2012, 19.8 in 2011, 19.5 in 2010).. This is remarkable, right? Because a moaty business such as IBM should be able to grow CFO, no?

 

Maybe it's interesting to list IBM's moats and see if this helps us determine whether we can expect growing CFO's going forward:

 

1. It's IBM, one of the most valuable brands in the world, which I believe in the IT business implies trust and reliability (you can't get fired hiring IBM). In addition, this should allow them to get (some) premium pricing + incorporating acquired companies should prove to be "easier" as they can leverage the product under the IBM umbrella

2. Switching costs: For existing clients who are running an IBM IT architecture I would think it's too risky/costly to switch architectures. Also, given the familiarity the IT personnel has with IBM's systems I would think you're really looking at entrenched customers.

3. Recurring revenues, with these entrenched customers IBM has succeeded in having "annuity like" contracts for both its software (2/3) and services (60%) divisions.

4. What also might be a moat is the fact that IBM has these three "multi billion dollar" divisions under one umbrella, thanks to its services business it can be very near to the client which could allow it to faster develop insights into what clients want/need. Combine this with one of the largest R&D budgets (and economies of scale as the three divisions benefit) and I think you have a fourth moat "source".

5. Anyone else.. ?

 

The only question is, if the list above are IBM's true moat's sources, do we expect these to increase/decrease in face of increased competition of the cloud and SaaS? I haven't yet researched that properly (and am also a little bit too tired at the moment) but it's obvious that when cloud providers start delivering computer resources, demand for IBM's servers and/or software will decline. If SaaS really breaks through, I can't (at least not yet) determine what the impact would be on IBM's middleware and related services/products, but it won't be positive? With the acquisition of Aspera and other, IBM is trying to augment its cloud services, the question is, will it succeed in creating a competitive offering??

 

I still have a lot of questions but thought I'd already share this piece to get a new discussion going, I have not yet made a final conclusion concerning the price (didn't run a DCF or anything).

 

Other upside which I haven't yet looked at: Watson (I did watch the youtube clip) and the shitload of patents they have..

[Phaceliacapital]

There’s no better case study than IBM when it comes to showing how a company can keep ahead of the ever-changing technology business. Big Blue brought computing to the corporate world with its mainframes in the 1960s and 1970s. Its desktop personal computer, introduced in 1981, set the standard for the machine that’s now almost ubiquitous in offices and homes. Up-and-coming computer makers pushed the company to the edge of bankruptcy in the 1990s before it adapted again, learning to sell services and software to help companies enter the Internet age. Now it faces new threats from cloud-services rivals and hasn’t figured out how to make much money from selling technical services to support the burgeoning corporate use of smartphones and tablets. Its shares fell 2.1 percent in 2013 versus a 26.2 percent gain for the S&P index of tech-company stocks, and a new CEO is faced with trying to change IBM’s spots again.

 

The Situation

 

After 20 years of steady sales growth and envied profits, IBM’s push into services is no longer enough to mask problems with its hardware units. The company reported on Jan. 21 that sales of the services divisions fell 3 percent in 2013 — total revenue has hovered at about $100 billion a year since 2007. Many companies that used IBM’s consultants to help set up in-house computer systems have begun renting server space from Amazon.com and signing up for sales-tracking software from Salesforce.com with a few clicks of a mouse. And other than Watson, the Jeopardy-playing supercomputer, IBM’s once-overflowing cupboards of innovation are looking bare. Financial engineering techniques such as buybacks and dividend increases now power the stock, not technology innovations. IBM was the only stock in the Dow Jones Industrial Average to drop in 2013.

 

The Background

 

Under Thomas J. Watson and his son, Thomas Jr., IBM used sophisticated research and groundbreaking sales management to dominate the nascent computing industry. By the 1990s, though, the company seemed to have no answer when rivals such as Digital Equipment and Compaq came up with cheaper alternatives to its profitable mainframes and other computers. Enter Louis V. Gerstner. The former McKinsey consultant and RJR Nabisco chief slashed more than 100,000 jobs and created a Global Services division that became the pre-eminent e-business consultant guiding companies struggling to deal with the rise of the Internet. Gerstner’s successor, Sam Palmisano, a career IBM salesman, took the helm in 2002 and kept profit high by selling the PC unit to Beijing-based Lenovo and building and buying software companies. (Palmisano has advised Bloomberg News’s parent company on privacy and data standards and serves on the board of Bloomberg Philanthropies.) Ginni Rometty became the first woman to lead IBM, in January 2012. An honors graduate in computer science, she’s talked of using Watson and other artificial intelligence technologies to help companies make sense of the torrent of data they collect. The stock fell to $187.57 at the end of 2013 after peaking at $215.80 in March. Her biggest move so far is right from the Palmisano playbook: She sold IBM’s PC server unit, yet another low-margin hardware business, to Lenovo on Jan. 23 for $2.3 billion.

 

The Argument

 

IBM fans — notably Warren Buffett, the company’s largest investor — love Palmisano’s promise, made in 2010, to boost earnings per share from $11.52 to $20 by 2015. Rather than strategic reinventions to rekindle sales growth, investors are banking on more buybacks and bigger dividends on top of steady cash flow. Analysts such as Brian Marshall of the International Strategy and Investment Group say it’s not that easy. If chasing that $20 EPS goal gets in the way of creating — or at least catching — the next big technology wave,  he argues, no amount of financial engineering will protect investors from the kind of decline suffered by onetime tech leaders such as Digital Equipment, Dell and Hewlett-Packard.

[spark411]

Maybe it's interesting to list IBM's moats and see if this helps us determine whether we can expect growing CFO's going forward:

 

1. It's IBM, one of the most valuable brands in the world, which I believe in the IT business implies trust and reliability (you can't get fired hiring IBM). In addition, this should allow them to get (some) premium pricing + incorporating acquired companies should prove to be "easier" as they can leverage the product under the IBM umbrella

2. Switching costs: For existing clients who are running an IBM IT architecture I would think it's too risky/costly to switch architectures. Also, given the familiarity the IT personnel has with IBM's systems I would think you're really looking at entrenched customers.

3. Recurring revenues, with these entrenched customers IBM has succeeded in having "annuity like" contracts for both its software (2/3) and services (60%) divisions.

4. What also might be a moat is the fact that IBM has these three "multi billion dollar" divisions under one umbrella, thanks to its services business it can be very near to the client which could allow it to faster develop insights into what clients want/need. Combine this with one of the largest R&D budgets (and economies of scale as the three divisions benefit) and I think you have a fourth moat "source".

5. Anyone else.. ?

 

__________________________________________________________________________________________

 

I think another huge moat and the one I am most reliant on is IBMs sales force and distribution channel.    When IBM buys a company, it can sell the new product faster than almost any other company.    IT Sales requires selling and training and IBM has the best infrastructure to do those two functions.  I think Buffet sees this as well.  Technologies come and go, but to maintain the best in breed training and sales infrastructure takes decades to create.

[Palantir]

I think that in the past, their brand name had a strong moat, but I personally don't view brand names as that powerful...one or two major mistakes and your brand value can start eroding very quickly, furthermore, could an IT manager be fired for buying Accenture? I don't really think so. I think IBM's core advantage is switching costs, their clients have multiyear contracts and it is very difficult for them to switch out of IBM infrastructure. I think Spark is correct in saying that their sales and distribution channel is also critical.

 

The issue for me is, what are they going to be selling? When it comes to applications, I think they have a good thing, and they can move these applications to a subscription based model in the future, which could make them even sticker. On the other hand, on the platforms side, they have a private cloud view, where companies build clouds of their own, but the largest area of growth has been in public cloud, even in the private cloud space, what is going to be their edge over AWS and Azure?