IBM - International Business Machines

[benchmark]

I am struggling to figure out Buffett's angle on this one.

 

If not for his investment and frankly the size of the bet, I would not give IBM much thought at all.

I very strongly believe that in the tech space if you don't innovate, move first or invest a ton of money in the next generation products, you are basically done as a company. IBM didn't do any of this and the stupidest thing they have done in my opinion is take on debt + fcf and repurchase shares with it. They did it to reach those insane eps targets for Wall Street crowd.

 

I think Druckenmiller is exactly right. These guys care a lot about their reported performance. This ensures mediocrity in Tech and mediocrity essentially means you are dead sooner or later.

 

To the argument that they are tightly integrated into government, finance, security etc...I heard this one before, I even believed it - the company was BBRY.

 

I believe WEB is a genius in investing, so no, unlike others I don't think he has lost his marbles on this one. He definitely has an angle. For the life of me I can't figure out what it is. Until now, after his BNSF purchase, I thought he was into investing in businesses which can not only generate lots of fcf, but also have the ability and runway to reinvest that in themselves.

 

Here I can't figure it out. There is cash flow, but it will die soon if not reinvested into something better. They had an opportunity 5 years ago to do so in cloud, they didn't and ceded the market to AWS, MSFT, GOOG et al. Just look at the competition, they all have their own cash flow moat machines and they are investing heavily. Except for MSFT( whose ATM, Windows is a mature product), GOOG ( search) & AMZN ( Ecommerce) are fast growing ATM's.

 

IBM has a declining ATM and they pissed away the cash and even took on debt to meet eps targets. I thought WEB didn't like the short term game...

 

Can anyone help me figure this out? WEB is betting here, at this stage in his career, because he sees something of true enduring value. What could that be?

+1, well side. Having worked for the big blue, the only thing that I can say that IBM has is the fact that 'you don't get fired for choosing IBM', maybe that's their moat. But IBM has always been a me-too company. I'm always puzzled by Web's huge bet on this -- almost makes me want to sell my BRK, as I don't know what Web sees that I'm missing..

[physdude]

I am struggling to figure out Buffett's angle on this one.

 

If not for his investment and frankly the size of the bet, I would not give IBM much thought at all.

I very strongly believe that in the tech space if you don't innovate, move first or invest a ton of money in the next generation products, you are basically done as a company. IBM didn't do any of this and the stupidest thing they have done in my opinion is take on debt + fcf and repurchase shares with it. They did it to reach those insane eps targets for Wall Street crowd.

 

I don't understand the debt criticism at all. Their debt (even if you don't exclude the global financing debt which is most of it) is quite reasonable given their FCF and the bond market definitely agrees given their excellent bond rating. OTOH, a company like AMZN with a pretty poor bond rating gets a pass on taking on a lot of debt without any real FCF to back it up (after properly accounting for capex using capital leases).

 

While IBM might have a lot of other problems, I can't see debt as being one of them particularly if you separate out the global financing debt since they would then have positive net cash.

[rpadebet]

I am struggling to figure out Buffett's angle on this one.

 

If not for his investment and frankly the size of the bet, I would not give IBM much thought at all.

I very strongly believe that in the tech space if you don't innovate, move first or invest a ton of money in the next generation products, you are basically done as a company. IBM didn't do any of this and the stupidest thing they have done in my opinion is take on debt + fcf and repurchase shares with it. They did it to reach those insane eps targets for Wall Street crowd.

 

I don't understand the debt criticism at all. Their debt (even if you don't exclude the global financing debt which is most of it) is quite reasonable given their FCF and the bond market definitely agrees given their excellent bond rating. OTOH, a company like AMZN with a pretty poor bond rating gets a pass on taking on a lot of debt without any real FCF to back it up (after properly accounting for capex using capital leases).

 

While IBM might have a lot of other problems, I can't see debt as being one of them particularly if you separate out the global financing debt since they would then have positive net cash.

 

My problem  is not with their creditworthiness, it's about their capital allocation. If I were evaluating their bonds for investment, I would look at their creditworthiness. I am evaluating their equity, so I am concerned about how they source and deploy capital

 

Like someone already said, I give zero value to what eps growth they have shown historically. I am more concerned about what that growth will be in future. Debt is a source of capital and IMO they pissed it away along with their FCF on repurchases instead of Investment in future castles and moats. How is that sustainable in future?

[scorpioncapital]

The 'currently' in Berkshire's statement is quite telling. I think it means that unless there is a surprise or material change. So obviously nothing that has happened to date they consider material - neither the currency headwind, nor the transformations - yes they have been slower than expected but that's not really material for now, nor anything else that has been thrown at the question of investing in IBM. Can you imagine how impatient markets have become these days? The road map was abandoned this year and we are 75% of the way to the goal. So it takes a little longer. Something is really up with financial markets, perhaps they are overvalued or something, they just can't seem to take any little setback in stride.

 

 

[ZenaidaMacroura]

With all the talk about why Donegan was onboard to sell PCP (I didn't think he was under much pressure - I had just started picking up shares when the buyout was announced) I would think that if IBM was smaller it would be a natural Berkshire pickup.  Everyone's yelling for Ginni's head and has an opinion on what the company should do going forward.  It seems like the quintessential point in the business' lifecycle for it to be brought into the fold at berkshire (I don't actually think this will  happen due to the number of owners, market cap size, etc etc).

[Palantir]

I am struggling to figure out Buffett's angle on this one.

 

If not for his investment and frankly the size of the bet, I would not give IBM much thought at all.

I very strongly believe that in the tech space if you don't innovate, move first or invest a ton of money in the next generation products, you are basically done as a company. IBM didn't do any of this and the stupidest thing they have done in my opinion is take on debt + fcf and repurchase shares with it. They did it to reach those insane eps targets for Wall Street crowd.

 

I don't understand the debt criticism at all. Their debt (even if you don't exclude the global financing debt which is most of it) is quite reasonable given their FCF and the bond market definitely agrees given their excellent bond rating. OTOH, a company like AMZN with a pretty poor bond rating gets a pass on taking on a lot of debt without any real FCF to back it up (after properly accounting for capex using capital leases).

 

While IBM might have a lot of other problems, I can't see debt as being one of them particularly if you separate out the global financing debt since they would then have positive net cash.

Did you account for Pension obligations as debt?

[Palantir]

I think this "not chasing after revenue growth" is a straw man. I think most critics of IBM, including myself get that IBM is trying to become smaller and shed business units, which will hurt revenue growth. The main reason people don't like IBM is because they don't feel it will be technologically and commercially relevant in the future, not because of the lack of revenue growth. If this line of reasoning is correct, repurchasing shares is not going to solve the problem.

 

Anyways, what is the target return that longs have here?

 

I can't speak for anyone else, but I'm not looking at this for massive upside or a quick double.  At 10% FCF yield I see it as a nice 10% earner with limited downside over the long term and good upside if they can stabilize the core and return to even single digit growth down the road. 

 

It returns pretty much all excess cash each year providing support for the downside and I don't have to worry too much about a Valeant like event cutting it in half.

 

10% is not bad, but it is not a super high RoR either. But why are you sure there is limited downside, especially if the criticism of IBM's business is correct? (Leave aside the buybacks for now). Right now we have a better business than IBM (AAPL) selling at a lower valuation, or a better business like MSFT selling at a comparable one...there are MLPs with near 10% sustainable distribution yields. IBM is not priced like it's going out of business! There are a number of good to decent businesses (WFM) at this valuation.

[KCLarkin]

I very strongly believe that in the tech space if you don't innovate, move first or invest a ton of money in the next generation products, you are basically done as a company. IBM didn't do any of this and the stupidest thing they have done in my opinion is take on debt + fcf and repurchase shares with it. They did it to reach those insane eps targets for Wall Street crowd.

 

It's so very easy to have an opinion. So very hard to have facts.

 

In 2014, Apple spent $6B on R&D. IBM spent $5.4B. My opinion is that $5.4 billion is a "ton of money". But what do I know.

[KCLarkin]

10% is not bad, but it is not a super high RoR either. But why are you sure there is limited downside, especially if the criticism of IBM's business is correct? (Leave aside the buybacks for now). Right now we have a better business than IBM (AAPL) selling at a lower valuation, or a better business like MSFT selling at a comparable one...

 

Oh...something intelligent from the bears!

 

I sold my Apple before the August correction, but I am reconsidering. BUT, it is a bit dangerous to call AAPL a better business. Every two years, Apple needs to sell you a new phone. Still, I think the moat is stronger than the market is giving them credit for. IBM versus AAPL is a valid choice. IBM has a better moat but secular headwinds. AAPL is better run and has secular tailwinds.

 

Microsoft might be a better business. I don't know. But it has a long history of taking large piles of cash and setting in on fire. I guess you could say IBM's buybacks have a similar effect. But, I can't see how you got a comparable valuation for IBM and MSFT. Microsoft looks like it is almost double the price to me.

 

If you are using EV, in your calculations, a few comments:

- IBM's debt is overstated because it doesn't net the finance receivables. The pensions might be an issue, but at least one guy did the analysis and decided that IBM's net debt is $0.

- Microsoft's cash is overstated because it is held offshore. At a minimum, you should give it a 35% haircut assuming taxes. But I would discount further. What value does that cash give the shareholder? At best, it is an option on a repatriation tax holiday.

 

Here is the analysis I refer to above. I don't trust anything on Seeking Alpha, but his analysis seems plausible:

http://seekingalpha.com/article/3657836-the-ibm-valuation-disagreement

 

 

 

[orthopa]

There is something I dont get about the Apple and IBM comparison, at least what the market is saying. Many would say Apple is a much better business then IBM. Revenues continue to grow significantly, eps continues to grow. They have a buyback and div too.  Why then does apple trade at a 11.8 times next years earnings (even less minus cash hoard) and IBM trades at 8.9 if its able to grow revenue consistently etc? What gives.

 

Also maybe I place too much trust in Berkshire but I have a hard time wrapping my head around Buffett, Munger, and the two deputies being grossly wrong on IBM. I understand IBM is a Buffett buy but you would think at some point after owning for 4 years one of the others would come to Buffett and let them know his concerns. Instead he keeps adding. I think this takes away any bias or misunderstanding of the situation at IBM.

 

I guess in saying IBM is a loser is equivalent to saying Buffett, Munger, Weschler, and Combs are wrong as I find it unlikely that the other 3 allow Buffett to throw Berkshire money down a hole.

[Jurgis]

I guess in saying IBM is a loser is equivalent to saying Buffett, Munger, Weschler, and Combs are wrong as I find it unlikely that the other 3 allow Buffett to throw Berkshire money down a hole.

 

I seem to remember another case widely discussed on this board where relying on a large number of pedigreed investors was not such a good idea...

 

... but Buffett is different! ;)

[TwoCitiesCapital]

I guess in saying IBM is a loser is equivalent to saying Buffett, Munger, Weschler, and Combs are wrong as I find it unlikely that the other 3 allow Buffett to throw Berkshire money down a hole.

 

I seem to remember another case widely discussed on this board where relying on a large number of pedigreed investors was not such a good idea...

 

... but Buffett is different! ;)

 

Damn....

 

Shots fired. Lol.

[dwy000]

10% is not a home run IRR but I'm not looking for IBM to double or triple.  I look at the 10% as a solid base case with limited downside.  Plus, most of that 10% is paid out to shareholders every year and isn't just held on the balance sheet of blown on silly acquisitions, so I don't have to wait and hope to earn it.  If they can steady the ship and start to show even 2-3% growth that 10% turns into 12-13%.  And if they do start to show growth I think the multiple will start to expand.  So the upside to me outweighs the downside risk and I get 10% while I wait.

 

Apple is a great company but it's not really comparable to IBM. Different business model.  The reason I see limited downside risk for IBM (there's ALWAYS risk) is that they have very long term contracts and sticky relationships with a giant backlog (over $100bn).  What did Ginni say, like 80% of banks and airlines?  That doesn't go away quickly.  I'm quite confident that IBM will still be around in 10 years and generating decent FCF, even in a downside scenario.

[Peregrine]

There is something I dont get about the Apple and IBM comparison, at least what the market is saying. Many would say Apple is a much better business then IBM. Revenues continue to grow significantly, eps continues to grow. They have a buyback and div too.  Why then does apple trade at a 11.8 times next years earnings (even less minus cash hoard) and IBM trades at 8.9 if its able to grow revenue consistently etc? What gives.

 

Also maybe I place too much trust in Berkshire but I have a hard time wrapping my head around Buffett, Munger, and the two deputies being grossly wrong on IBM. I understand IBM is a Buffett buy but you would think at some point after owning for 4 years one of the others would come to Buffett and let them know his concerns. Instead he keeps adding. I think this takes away any bias or misunderstanding of the situation at IBM.

 

I guess in saying IBM is a loser is equivalent to saying Buffett, Munger, Weschler, and Combs are wrong as I find it unlikely that the other 3 allow Buffett to throw Berkshire money down a hole.

 

Who knows where smartphone margins will go? Is it sustainable for Apple to be earning damn near 100% of the industry's profits? Will Apple eventually have to follow price cutting by Android manufacturers? Can their market share remain the same? It's hard to say.

 

With IBM, there is a strong degree of vendor lock-in. My dad, who works at a similar company like CGI, sees just how strong it is. Now with the cloud and new technologies, IBM's primacy with their clients may be diminishing some but the business is less prone to competitive attacks.

[scorpioncapital]

Currently, it looks like IBM is doing 20%+ IRR, and 11%+ yield to external investor.

This is what I'd call a positive gradient, your yield is going to converge with the IRR over a few years OR the IRR is going to converge with your yield. If the latter, this is a bad investment. If the former, this is a bond with an expanding coupon.

 

[Mephistopheles]

Re: People at Berkshire being against the IBM investment - Gates said in an interview earlier this year that he doesn't agree with Warren on this one. I think it was an FT interview around the time of the annual meeting.

[LowIQinvestor]

The below numbers are fairly strong for a company that is supposedly in decline?

 

Services segment

3Q15: Backlog $118B up 1% in Constant Currency

 

Op. Gross Profit Margin 50.0% (flat)

[scorpioncapital]

Re: People at Berkshire being against the IBM investment - Gates said in an interview earlier this year that he doesn't agree with Warren on this one. I think it was an FT interview around the time of the annual meeting.

 

The quote,

 

“No, IBM became less of a technology company,” Mr Gates says. “It’s really sad. It turns out, at least so far, Warren was wrong. Even with the enterprise customers, the cloud has not been saleable for them. I’m biased. IBM is a wonderful company but because I competed with them for many, many decades I have to say, I don’t see their future as brightly as people who are long on the stock.”

"

Btw, ironically that quote came from May 2015 when IBM stock was at it's all time peak. Kind of prescient of Gates!

[Range]

Re: People at Berkshire being against the IBM investment - Gates said in an interview earlier this year that he doesn't agree with Warren on this one. I think it was an FT interview around the time of the annual meeting.

 

The quote,

 

“No, IBM became less of a technology company,” Mr Gates says. “It’s really sad. It turns out, at least so far, Warren was wrong. Even with the enterprise customers, the cloud has not been saleable for them. I’m biased. IBM is a wonderful company but because I competed with them for many, many decades I have to say, I don’t see their future as brightly as people who are long on the stock.”

"

Btw, ironically that quote came from May 2015 when IBM stock was at it's all time peak. Kind of prescient of Gates!

 

IBM stock hit its all time high in March 2013.  Gates' comment was roughly at the 2015 high, but not at the all time peak.

[KCLarkin]

“IBM is a wonderful company but because I competed with them for many, many decades I have to say, I don’t see their future as brightly as people who are long on the stock.”

 

It's interesting to compare IBM versus Microsoft.

 

MSFT, IBM               

10 yr rps: 12%, 6%

10 yr eps: 9.5%, 13%

5 yr rps: 9%, 5%

5 yr eps: 7%, 11.5%

 

So, at least over this short period, IBM's strategy of focusing on value over growth seems correct. Now, we have a choice:

A - Overweight recent performance because there is clear evidence of secular decline

B - Discount recent performance given the longer term track record

 

I won't disparage anyone for choosing A. I have been long this stock long enough to admit I was wrong. But anyone who questions why WEB bought this, clearly is not paying attention to the facts. The 25% EPS increase in 2008 should be reason enough for this to trade at a premium to the S&P.

 

[ccplz]

The past doesn't matter...

[LowIQinvestor]

I believe in 2008 IBM hit a trough multiple to earnings of around 9.

 

And here we are today around a 9 PE.

 

I put some in my kids' accounts today.

[rpadebet]

The past doesn't matter...

 

Maybe the past matters a little bit...

 

It is useful in understanding how the eps growth was achieved in the past. That is in turn useful in forecasting somewhat intelligently how sustainable that sort of growth is in the future.

 

If they had achieved this growth in EPS via new products/services or increased unit sales of existing products, then it is quite sustainable or repeatable. However since they achieved it primarily through buybacks, the sustainability in future is iffy. That is why the low multiple makes sense..

[Palantir]

Increasing eps with buybacks is the same as increasing eps with acquisitions. It's not true growth.

[dwy000]

Increasing eps with buybacks is the same as increasing eps with acquisitions. It's not true growth.

 

I don't think it's done for growth, I think it's done to return capital to shareholders.  The consequence of doing it is growth in EPS (which theoretically, with no change in multiple, should result in share price growth).  But it certainly isn't growth in the underlying business.