IBM - International Business Machines

[original mungerville]

For you Ginni Rometty admirers:

 

"IBM CEO Ginni Rometty on Cloud-Based Watson Health"

 

http://www.bloomberg.com/news/videos/2015-04-17/ibm-ceo-ginni-rometty-charlie-rose-04-17-?cmpid=yhoo

 

She was very impressive in that interview. She definitely looks like a strong leader that knows where she wants to go with the company.

[Jurgis]

For you Ginni Rometty admirers:

 

"IBM CEO Ginni Rometty on Cloud-Based Watson Health"

 

http://www.bloomberg.com/news/videos/2015-04-17/ibm-ceo-ginni-rometty-charlie-rose-04-17-?cmpid=yhoo

 

She was very impressive in that interview. She definitely looks like a strong leader that knows where she wants to go with the company.

 

My opinion is completely opposite. IMHO, she is not a good leader. She tries to talk the talk, but even talk is not impressive. And the execution is even worse.

 

I am back in the bear camp. I sold my IBM position today. Of course, I have a fractional ownership through BRK and FFH.

 

The only positive thing I can say is their reporting is good. You can immediately see the sales going down the drain. :)

And, no, I disagree with people who say that sales growth does not matter. Yes, sales growth that leads to declining earnings is not good. But sales going down is not good either. You can milk the margin cow only so much. At some point you have to grow to deliver returns.

[cubsfan]

Well, if they are getting rid of low margin businesses like commodity servers,etc,  that seems like the right thing to do.

I would expect the revenues to decline significantly. But Mainframes and high end server revenues are up a lot - those are high margin.

And if the focus is on high margin software and services - that's also a positive. Stock buybacks - positive. etc,etc.

 

You also have a bunch of revenue noise because of currency issues - which may eventually reverse in IBM's favor.

 

It should not be all about revenue growth. Maybe they need to shrink first to transition to high margin businesses?

 

BTW - I have no dog in this hunt, no position. But they look to be making the right moves.

[Jurgis]

Well, for me "shrink to grow" strategy does not make sense.

 

Sure, if you are bleeding cash in commodity servers or chips, you might want to sell. Although even that is not given if you are in the business of providing complete solutions where one part of the business feeds another one. (It's like KOs maneuvers with bottlers - it's pushing things back and forth and alternatively arguing that you need the bottlers inside company or you need them outside company...)

 

But it's not even that. IBM is not growing even without the bleeding parts.

 

So now the bulls say: "shrink to grow". This is IMHO highly flawed reasoning. The fact that you just sold underperforming divisions does not make other divisions magically grow more. Yeah, maybe they will get more management attention. But really if these were "good" divisions, they should have gotten tons of management attention already. It's again like KO - will KO sales just magically start growing because they divested bottlers? Why?

 

So you look at slide 6 of http://yahoo.brand.edgar-online.com/displayfilinginfo.aspx?FilingID=10635431-821-232461&type=sect&TabIndex=2&dcn=0001104659-15-028716&nav=1&src=Yahoo and you say 30% hardware growth is wonderful. But part of this is also temporary - there was a generation shift and buyers delayed their purchases to buy new generation of HW. And everything else is negative. Software - which should be the growing area. And this is all after removing the effects of divestitures... And margins are shrinking too.

 

Anyway on high level, I'd love companies that would divest bad divisions when they are growing and doing well elsewhere. That would be great business acumen. Unfortunately, almost no one does this. While the company is growing and doing fine, the bad divisions are carried around. Only when the main "good" businesses get into trouble, they start thinking about "shrink to grow". So sorry that I am jaded about this concept.  ::)

[Jurgis]

So IMHO bull case is not about IBM's current business, it's about a potential for IBM to grow in the future, which makes it a speculative investment. If you are right and IBM grows, then you get good returns. If you are wrong and they continue to lose 5%+ revenues per year, well...

 

Yes, IBM has a huge moat in some of their businesses. It is just not clear to me that this moat applies to more than around 40% of their business. (Yeah, 40% is rather out of the hat, we can try to narrow it down, but I really doubt it's more than 60% :) . It might be less than 30% too :) ). So it can keep losing business for a while until the moat parts are hit.

 

Another argument for bulls is the cheap (?) price. Yes, this could give some margin of safety. The cheapness depends a lot on how investor views the GF debt and pension obligations though. If you assume that either or both of these are real EV contributors, then the price is not so cheap anymore.

[NewbieD]

The death of the mainframes have been predicted for 20 years now. And they are still going strong and provide great profits to IBM.

 

Death will come sooner or later. My software testing friend is testing a new core system that will be deployed in 1 month at a 2nd tier bank in Sweden.

But from an investing point of view most of the decline is far out. And who better to replace mainframes than those who built the things in the first place 8)

 

I bought some today. Don't care much about growth as long as they seem to be allocating well and shareholder friendly.

[cubsfan]

The death of the mainframes have been predicted for 20 years now. And they are still going strong and provide great profits to IBM.

 

Death will come sooner or later. My software testing friend is testing a new core system that will be deployed in 1 month at a 2nd tier bank in Sweden.

But from an investing point of view most of the decline is far out. And who better to replace mainframes than those who built the things in the first place 8)

 

I bought some today. Don't care much about growth as long as they seem to be allocating well and shareholder friendly.

 

Again, that is the same line of 20 years ago - "mainframes are dead" - I doubt it.

[cubsfan]

So IMHO bull case is not about IBM's current business, it's about a potential for IBM to grow in the future, which makes it a speculative investment. If you are right and IBM grows, then you get good returns. If you are wrong and they continue to lose 5%+ revenues per year, well...

 

Yes, IBM has a huge moat in some of their businesses. It is just not clear to me that this moat applies to more than around 40% of their business. (Yeah, 40% is rather out of the hat, we can try to narrow it down, but I really doubt it's more than 60% :) . It might be less than 30% too :) ). So it can keep losing business for a while until the moat parts are hit.

 

Another argument for bulls is the cheap (?) price. Yes, this could give some margin of safety. The cheapness depends a lot on how investor views the GF debt and pension obligations though. If you assume that either or both of these are real EV contributors, then the price is not so cheap anymore.

 

If the stock stays low, but the transition to high margin business occurs, and IBM buys back lots of stock - shareholders will likely do just fine.

At the rate they are buying back stock with excess cash - might end up like Autozone - where moderate revenue growth (10%) and share

shrinkage drive the EPS enormously.

[Jurgis]

At the rate they are buying back stock with excess cash - might end up like Autozone - where moderate revenue growth (10%) and share

shrinkage drive the EPS enormously.

 

Yes. If only they had moderate revenue growth. ;)

[vinod1]

To me the investment case boils down simply to

 

1. Is it an above average business?

2. Is it selling at a below average price?

 

The answer to both these questions is unambiguously yes and by a significant amount.

 

Or to put it in another way, a business of IBM's quality deserves to be valued at a much higher level than 10 PE.

 

Vinod

[Jurgis]

1. Is it an above average business?

2. Is it selling at a below average price?

 

If you put it like that, I disagree with 1.

 

Edit: to elaborate, I believe that IBM has at most 60% of sales in above average business that is not growing. The rest is potentially a melting ice cube.

 

Edit2: to be complete, I will also disagree with 2. :) If I put GF debt and pension liabilities into EV, IBM is trading at below 5% E/EV.

[cubsfan]

But IBM has ROE's and ROIC's that suggest IBM is a far from an average business.

They have a tremendous amount of high margin & annually recurring revenue.

It looks like a very good business indeed - even with flat revenues.

You might be underestimating the moat the company has.

And they seem to use their balance sheet very well.

 

Maybe it's akin to owning a good apartment building in a nice part of town.

One that is fully occupied and has high stable rents - the building doesn't have

to appreciate for it to be a very good investment.

[Eye4Valu]

Buffett doesn't know what he's doing, but Jurgis does. Sell out of Big Blue and Berkshire before you make a return on your investment!

[constructive]

Edit2: to be complete, I will also disagree with 2. :) If I put GF debt and pension liabilities into EV, IBM is trading at below 5% E/EV.

 

Why would you value a $160B market cap company with AA rated debt on enterprise value instead of focusing on equity?

 

The main advantage of EV valuation is that it gives you the perspective of a private acquirer - no one is going to acquire IBM.

[Jurgis]

Buffett doesn't know what he's doing, but Jurgis does. Sell out of Big Blue and Berkshire before you make a return on your investment!

 

Ah, personal attacks. OK, I am out of this discussion. Have fun.

[cubsfan]

Dude - don't give up so easily. This is supposed to be an exchange of ideas among investors. Different viewpoints.

 

Besides, you were already getting there. You yourself said IBM has a strong moat for 40% of their business, but you were not

sure about the rest. So you're not sure about the rest - but the very high ROE/ROIC tells you there is a big moat. I can't tell you

why - but it's there. So it's a great business - now we can all debate why IBM is going down the drain - but at the same time

IBM management is smart and has multiple levers they it can pull to keep returns high: they can close down subpar businesses,

they can lay off people (since most of their cost IS people), they can buy back cheap stock,  they can buy more software companies,

they can use debt well because they have dependable recurring revenue, etc, etc.

 

The point is: it's not all about revenue growth. This management team is smart and adaptable.

 

And the earnings report is messy and cloudy because of currency issues (strong dollar impact) - and future revenue issue might look worse than it is.

 

But don't go away mad. We respect your opinion.

[rpadebet]

Ibm has a moat. It couldn't have survived this long without one in the industry it operates in.

Having said that, even WEB has said he likes businesses to not only have a moat,but work everyday to widen it.

 

IBM's main mistake in my opinion was to waste the tremendous cash flows into buying back stock. They were focussed more on the scoreboard than on the playing field.

 

While younger and savvy companies like AMZN invested their cash flows into building the cloud business, IBM was focussed on reducing share count.

 

Even MSFT was late here, but they were smart enough to at least be in the game. IBM wants to join now when the other players have a big head start and/or big cash piles. I think it's tough for IBM to do anything meaningful here.

 

Their core moated business will continue to churn cash ,but the moat is weakening every day. Their high roic and margins elsewhere are result of services sold on top of the mainframes. It's operational leverage and it will hurt badly when the core businesses start migrating to the cloud.

 

Just my 2 cents ( invested via brk)

[oddballstocks]

IBM's moat is in my view indisputable. I've worked in environments that buy IBM, they buy giant systems that are so deeply integrated it would cost hundreds of millions to replace. Think about that, large international companies willing to spends hundreds of millions to disrupt their business to replace software. Unless something is egregiously broken it's not going to happen.

 

I don't buy the story that IBM is run by a lot of smart people. There is serious brain drain there, I know a lot of former blue people. The good ones are gone and have taken their friends with them.

 

Here's the thing though. IBM has two aspects on this that are interesting. Former IBM'ers still respect the company and look to use IBM products at their new ventures. This is almost a weird sales effect where the best employees leave, talk about how terrible IBM has become and then approve million dollar purchases of IBM software.

 

The second is that IBM has a very good acquisition team. They have a track record of acquiring excellent companies and integrating the product into their product line. No genius needed here. Buy the genius then resell.

 

I've worked with IBM, Oracle, Sun, BEA and other giant enterprise level software. They all have differing levels of terribleness. But they all have advantages that are almost unbeatable. These enterprise packages can scale very easily. A customer with an average IT team can build out their org for tens of thousands of employees with the assurance the software will just work. Yes, someone will probably need to babysit some strange functionality, but it will work. Now co pare this to trying to scale a homegrown solution. You have companies like Google doing it, but they are hiring rocket scientists to build this stuff. A B-level student from MidWest State School can roll out WebSphere or DB2. No rocket scientist required.

[kevin4u2]

Everyone is focused on the lack of revenue growth at IBM but they miss the mark.   

 

Management has done an excellent job with the company.  Here is how:

 

Ten year revenue growth per share 6%.

Ten year earnings growth per share 13%

Ten year dividend growth per share 19.5%

Over the last ten years, Operating Margin is up 10% to 26%

Over the last ten years, Net Profit Margin is up 7.7% to 17%

Over the last ten years, Return on Total Capital is up 16.3% to 34.5%. 

 

Operationally, that is incredible performance and everyone is all bent out of shape over a lack of revenue growth.  They generate much higher returns from their assets than ever before.  I would love to see the average armchair analyst demonstrate that type of performance.  Perhaps IBM knows how to invest capital, and they know how to do it very well. 

 

How many businesses earn that level of return on capital?  How about Amazon, what is their Operating Margin? 5.5%. Net Profit Margin? 0%. Return on capital? 0%.  Why does Amazon get a pass? 

 

As for the CAPEX argument, let's look at some facts.  Both companies spend roughly the same amount on CAPEX as each other, at around $4.5 billion.  Everyone says IBM doesn't invest in their business.  We'll no, they just happen to generate over $20+ billion per year in CF, they invest the same amount as AMZN and still happen to have $15+ billion in free cash to pay dividends and buyback shares.  AMZN generates $4.5 billion in CF and invests the same amount in CAPEX, makes no money doing it, yet they are awesome. 

 

Amazon is great for social good, we all enjoy the benefits.  The problem is their business model benefits consumers and not investors.  It's basically a free service.  To those who are shareholders, I send my deepest thanks.

 

[enoch01]

IBM's moat is in my view indisputable. I've worked in environments that buy IBM, they buy giant systems that are so deeply integrated it would cost hundreds of millions to replace. Think about that, large international companies willing to spends hundreds of millions to disrupt their business to replace software. Unless something is egregiously broken it's not going to happen.

 

I don't buy the story that IBM is run by a lot of smart people. There is serious brain drain there, I know a lot of former blue people. The good ones are gone and have taken their friends with them.

 

Here's the thing though. IBM has two aspects on this that are interesting. Former IBM'ers still respect the company and look to use IBM products at their new ventures. This is almost a weird sales effect where the best employees leave, talk about how terrible IBM has become and then approve million dollar purchases of IBM software.

 

The second is that IBM has a very good acquisition team. They have a track record of acquiring excellent companies and integrating the product into their product line. No genius needed here. Buy the genius then resell.

 

I've worked with IBM, Oracle, Sun, BEA and other giant enterprise level software. They all have differing levels of terribleness. But they all have advantages that are almost unbeatable. These enterprise packages can scale very easily. A customer with an average IT team can build out their org for tens of thousands of employees with the assurance the software will just work. Yes, someone will probably need to babysit some strange functionality, but it will work. Now co pare this to trying to scale a homegrown solution. You have companies like Google doing it, but they are hiring rocket scientists to build this stuff. A B-level student from MidWest State School can roll out WebSphere or DB2. No rocket scientist required.

 

Great commentary, thanks Nate.

[sleepydragon]

IBM's moat is in my view indisputable. I've worked in environments that buy IBM, they buy giant systems that are so deeply integrated it would cost hundreds of millions to replace. Think about that, large international companies willing to spends hundreds of millions to disrupt their business to replace software. Unless something is egregiously broken it's not going to happen.

 

I don't buy the story that IBM is run by a lot of smart people. There is serious brain drain there, I know a lot of former blue people. The good ones are gone and have taken their friends with them.

 

Here's the thing though. IBM has two aspects on this that are interesting. Former IBM'ers still respect the company and look to use IBM products at their new ventures. This is almost a weird sales effect where the best employees leave, talk about how terrible IBM has become and then approve million dollar purchases of IBM software.

 

The second is that IBM has a very good acquisition team. They have a track record of acquiring excellent companies and integrating the product into their product line. No genius needed here. Buy the genius then resell.

 

I've worked with IBM, Oracle, Sun, BEA and other giant enterprise level software. They all have differing levels of terribleness. But they all have advantages that are almost unbeatable. These enterprise packages can scale very easily. A customer with an average IT team can build out their org for tens of thousands of employees with the assurance the software will just work. Yes, someone will probably need to babysit some strange functionality, but it will work. Now co pare this to trying to scale a homegrown solution. You have companies like Google doing it, but they are hiring rocket scientists to build this stuff. A B-level student from MidWest State School can roll out WebSphere or DB2. No rocket scientist required.

 

Great commentary, thanks Nate.

 

"I don't buy the story that IBM is run by a lot of smart people"

I agree with this. JPM is similar. People whom I know of working at JPM are less smart than people I know at GS. But there's so many politics at GS nothing get done and smart people leave. I like business where it is very profitable even though it's run by less smart people. it's a good indication that the business model or culture there is very good and productive.

[Txvestor]

Everyone is focused on the lack of revenue growth at IBM but they miss the mark.   

 

Management has done an excellent job with the company.  Here is how:

 

Ten year revenue growth per share 6%.

Ten year earnings growth per share 13%

Ten year dividend growth per share 19.5%

Over the last ten years, Operating Margin is up 10% to 26%

Over the last ten years, Net Profit Margin is up 7.7% to 17%

Over the last ten years, Return on Total Capital is up 16.3% to 34.5%. 

 

Operationally, that is incredible performance and everyone is all bent out of shape over a lack of revenue growth.  They generate much higher returns from their assets than ever before.  I would love to see the average armchair analyst demonstrate that type of performance.  Perhaps IBM knows how to invest capital, and they know how to do it very well. 

 

How many businesses earn that level of return on capital?  How about Amazon, what is their Operating Margin? 5.5%. Net Profit Margin? 0%. Return on capital? 0%.  Why does Amazon get a pass? 

 

As for the CAPEX argument, let's look at some facts.  Both companies spend roughly the same amount on CAPEX as each other, at around $4.5 billion.  Everyone says IBM doesn't invest in their business.  We'll no, they just happen to generate over $20+ billion per year in CF, they invest the same amount as AMZN and still happen to have $15+ billion in free cash to pay dividends and buyback shares.  AMZN generates $4.5 billion in CF and invests the same amount in CAPEX, makes no money doing it, yet they are awesome. 

 

Amazon is great for social good, we all enjoy the benefits.  The problem is their business model benefits consumers and not investors.  It's basically a free service.  To those who are shareholders, I send my deepest thanks.

 

Good perspective. However let me remind you that all of the above was achieved with their debt to equity going from 0.68 to 3.44. With LT debt going from circa 15billion to over 35billion.

Now i beleive in the investment thesis and have a long position etc. and I agree that for a company with such stable and recurring cash flows in the midst of a transition, and with such historically low interest rates it was arguably the right thing to do for shareholders. That said the company has levered up significantly and once revenues start growing again, will need to shift gears to deleveraging the balance sheet rather than continue share buybacks. I suspect thats what they are going to do as well.

[tombgrt]

Won't they be able to both deleverage the BS and buy back shares (or spend on growth) when revenues start to grow again? Keeping debt at the same level while CF grows on an absolute basis would already mean deleveraging. CF likely shouldn't be used further to pay down debt but should be used for growth and buybacks as the expected return will be much higher. Especially given the high level of recurring revenues, I don't see how the BS is overleveraged?

[KCLarkin]

Non-financing debt is under $15B. That's about 1 year of FCF. I can't follow your argument that IBM needs to delever.

[smd123]

To add to KCLarkin's comment:

-> non-GFC debt is ~$15b

-> cash + marketable securities are ~ $10b.

 

This, for a company that makes ~$90b in revenue and $17b in operating cash flow. The strategic imperatives for IBM, which constitute 1/4 th of their revenues, are growing at about 16%.

 

Even if you assume no growth in revenues, the current valuation is pricing IBM for more gloomy weather. For a company that penetrates 90-95 out of every 100 banks and hospitals, Mr. Market's assessment is worth (re)-looking at.