IBM - International Business Machines

[KCLarkin]

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..

 

I sure am glad so many of you have taken time off from VRX to share your opinions on IBM. Your in-depth analysis is quite useful in making rational investment decisions. I had forgotten that IBM bought back 25% of their shares in 2008 creating a phony 25% EPS gain.

[AzCactus]

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..

 

I sure am glad so many of you have taken time off from VRX to share your opinions on IBM. Your in-depth analysis is quite useful in making rational investment decisions. I had forgotten that IBM bought back 25% of their shares in 2008 creating a phony 25% EPS gain.

 

KC-Am I safe in assuming you are long IBM?  Most of the names you talk about OUTR, CMPR etc are pretty fascinating.  Would love to hear how your opinion of IBM compares to some of the other holdings you have or are looking at?

[KCLarkin]

KC-Am I safe in assuming you are long IBM?  Most of the names you talk about OUTR, CMPR etc are pretty fascinating.  Would love to hear how your opinion of IBM compares to some of the other holdings you have or are looking at?

 

I have been long this stock long enough to admit I was wrong. I consider it a defensive position which I expected to cushion my portfolio in a major correction. That thesis hasn't played out. IBM was my only loser last year and my biggest loser this year.

 

I would like to reduce my exposure but current price does not seem rational.

[rpadebet]

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..

 

I sure am glad so many of you have taken time off from VRX to share your opinions on IBM. Your in-depth analysis is quite useful in making rational investment decisions. I had forgotten that IBM bought back 25% of their shares in 2008 creating a phony 25% EPS gain.

 

I don't think making this personal or bringing in VRX adds anything except entertainment value. I still prefer VRX as an investment and I am sure you would stick with your IBM. All I am trying to figure out here is whether there is some sort of 2nd level thinking WEB employed in making this such a big investment of his.

 

Everyone can see IBM's past numbers. Nothing to misunderstand there. Yes EPS has grown, multiple has compressed, so the question is why is the market wrong in compressing the multiple? What is it that we "would be" investors are missing here?

 

And lets also stop bragging about them making 50% on their investment in 7 years? If they had invested in S&P at the same time they would have more than doubled that return. Would you invest with such an under-performing manager?

 

For some perspective, in 2008 when IBM was busy purchasing those shares, one of its competitors was aggressively investing in nascent cloud initiatives and today it is leading that market by a mile, while IBM is still thinking about playing catch up there despite their billions in R&D investments each year.

 

PS: IBM's historical fundamentals, 10K and 10Q's look a lot prettier compared to VRX. Hope that helps.

 

[Picasso]

Looks like VRX is leaking all over the board.

 

Buffett bought IBM because he knew that the reinvested earnings over time would mean Berkshire would own IBM at some point in the future.  I don't think it was a more complicated decision than that.

 

He also mentioned the roadmap to $20 EPS, and he was wrong about that.  The good news is he can eventually own IBM if the shares keep trading like our other favorite stock, VRX.

[AzCactus]

Looks like VRX is leaking all over the board.

 

Buffett bought IBM because he knew that the reinvested earnings over time would mean Berkshire would own IBM at some point in the future.  I don't think it was a more complicated decision than that.

 

He also mentioned the roadmap to $20 EPS, and he was wrong about that.  The good news is he can eventually own IBM if the shares keep trading like our other favorite stock, VRX.

 

Do you mean own outright or just more of the company?

[rpadebet]

Looks like VRX is leaking all over the board.

 

Buffett bought IBM because he knew that the reinvested earnings over time would mean Berkshire would own IBM at some point in the future.  I don't think it was a more complicated decision than that.

 

He also mentioned the roadmap to $20 EPS, and he was wrong about that.  The good news is he can eventually own IBM if the shares keep trading like our other favorite stock, VRX.

 

Yes seems like we can't keep VRX out of anything these days...

 

But to your point Picasso, why would he want to own IBM outright? How does t better his returns

[Picasso]

Eventually Berkshire will own the majority of IBM or the share price will perform strongly and he'll do just fine on the stock.  He wants the stock to go down as long as IBM continues to pay their excess cash flows in buybacks/dividends. 

 

I noticed another "sign" regarding this idea.  He mentioned once before that IBM earns infinite returns on tangible equity as why he likes the business.  IBM can't get those kinds of returns by reinvesting all that excess cash flow back into the business so why not pay it back out so shareholders can reinvest it in more IBM shares? 

 

I think it ignores that IBM isn't destined to have a moat just because it's IBM.  This is a tech company after all.  They may not be getting the same returns in incremental capital invested as the core business but that doesn't mean the current ROIC isn't going to be eroded over time.  On the surface it seems like an easy investment, but underneath is a more complicated picture. 

[Picasso]

Looks like VRX is leaking all over the board.

 

Buffett bought IBM because he knew that the reinvested earnings over time would mean Berkshire would own IBM at some point in the future.  I don't think it was a more complicated decision than that.

 

He also mentioned the roadmap to $20 EPS, and he was wrong about that.  The good news is he can eventually own IBM if the shares keep trading like our other favorite stock, VRX.

 

Yes seems like we can't keep VRX out of anything these days...

 

But to your point Picasso, why would he want to own IBM outright? How does t better his returns

 

Well, IBM generates massive amounts of cash on tangible equity.  If you think IBM is a durable business and you have all that excess capital to deploy, isn't that what Berkshire is looking for?  Look at what SIRI has become for LMCA.  Eventually you can just roll it up inside the "parent" and have access to all those excess cash flows.  That's worth a lot to Berkshire.

 

And if it doesn't happen because the share price performs well, that's not too bad of an outcome either.  Buffett really thinks this is a durable business so I don't think he expects downside on his cost.  That's why I think it was such a large bet for him when he first disclosed the stake.  It's really a no brainer if you think about it that way.

 

How many other investors here would be willing to put up with ten years of pain?  Berkshire can deal with it because that's what they're hoping for.

[Guest Schwab711]

Although it may not seem like it would move the needle, I think it makes a lot of sense for IBM to buy FICO. FICO has a Big Data business that could be integrated, software in fragmented markets (notably, fraud), and is the best at decision making software. Combine IBM's lead in predictive analytics with FICO's lead in decision making and you would have a power house (not to mention the cross-selling to FICO's bank customers).

 

I don't want to see FICO purchased but I think it would make a lot of sense.

[KCLarkin]

Everyone can see IBM's past numbers. Nothing to misunderstand there. Yes EPS has grown, multiple has compressed, so the question is why is the market wrong in compressing the multiple? What is it that we "would be" investors are missing here?

 

I'm not trying to get personal. I just get annoyed when people litter the boards with opinions when they haven't done the work. They didn't really buyback 25% of their shares, I was trying to show the flaw in your narrative. THIS is one part of the IBM narrative that is very wrong. IBM invested very heavily in growth. From 2000-2008, they spent $110B on CapEx, Acquisitions, and R&D.

 

Anyone who has listened to the 2011 conference calls knows why WEB bought this stock. There is no great level of insight needed. This was a company kicking ass and taking names. If he could predict Snowden and the US dollar and white-label data centers and AWS, he might have made a different bet. We are judging him on decision he made in 2011 based on today's facts.

 

Multiple is depressed because the market believes IBM is in secular decline because of AWS. Current performance of the business reinforces that perception. End of story. In 5 years, we'll know for sure.

 

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I want to have a healthy debate on IBM, but I just kill brain cells having the same debate ten times because people are too lazy to read the whole thread. I banned myself from VRX for this reason. Time for another ban.

[Picasso]

From 2000-2008, they spent $110B on CapEx, Acquisitions, and R&D.

 

Where is the return on that spend?  Now add up the following several years up until today and compare it to operating income.  And not on a "per share" basis.

 

That's a big reason why the shares are flat lining. 

[Guest qanary]

Maybe not because of AWS, from March of this year:

 

Buffett said that the cloud space, which IBM is making a big push into, is not a "winner take all" business, and Buffett said that if you ask some of America's biggest companies if they're doing a lot of business with IBM, the answer is and will likely continue to be "yes."

 

And May:

 

“I feel pretty good about IBM’s future, probably more so in what they call the hybrid cloud. IBM is a trusted organization. It’s an innovative organization,” said Buffett.

 

 

If he could predict Snowden and the US dollar and white-label data centers and AWS, he might have made a different bet. We are judging him on decision he made in 2011 based on today's facts.

 

[gjangal]

Imo Mr. Buffett has a problem with ever increasing cash. If you look at it, 12b out of a portfolio value of ~110b is a high percentage (11%). but even if he loses 50% on this , it's a a hit of 5%. Nothing he can't recover from. Also one of the few opportunities he can deploy cash to work at this scale. For someone who has followed ibm for 50 years, it has to be a conviction buy with assumptions and and hence the large sizing. If he is right he earns 10% a year for some time  else loses 5% of his capital and hopefully gets out in 3 months before the market gets wind of it

[hunterny]

Sorry, I'm a newb and can't figure out how to quote your comments about IBM being a no brainer, Picasso.  My comments are:

 

I think "excess cash flows" is a tempting rationale to ascribe to WEB, however it would only add to the challenges Berkshire faces in redeploying the excess cash flows from its existing operating businesses.  On the contrary, several recent opco investments made (e.g. BNSF) were justified for exactly the opposite reason: that they will consume considerable cash flows that can be reinvested within themselves, thereby reducing the concern that future custodians of BRK (ex-WEB) will have to rely on stock-picking and acquisitions to generate growth in intrinsic value.

 

By the same token, IBM's current cash flow characteristics themselves (high CF from equity) are a red herring; the question of whether you assume it's a durable business (and what vector the future cash flows will take--precipitous decline vs. stable) is what some of the posters have correctly been trying to get a handle on.  And if we assume WEB is indeed viewing this investment rationally, he has to be liking the standalone returns potential of this investment, regardless of how much free cash flows he does or doesn't need in BRK.

 

I'm on the fence about IBM at today's prices.

 

[scorpioncapital]

http://finance.yahoo.com/news/amazon-s-cloud-success-stokes-fears-of-old-tech-failures-163810909.html

 

"Now some analysts and investors are starting to consider the flip side -- what's surprisingly good news for Amazon and a few other cloud providers like Microsoft (MSFT) and Alphabet's (GOOGL) Google is probably the precursor to surprisingly bad news for traditional IT giants like IBM (IBM), Hewlett Packard Enterprise (HPQ) and others. And they say that they're starting to cut back on stocks and bonds of the lagging players, fearing an accelerating downward cycle.

 

"Some of this is already priced in, but what's not priced in is how quickly all this is happening," Rahim Shad, tech analyst at fund manager Invesco, says. "The pace is going to surprise the HP's, the Dell's, the EMC's.""

 

[KCLarkin]

Where is the return on that spend?  Now add up the following several years up until today and compare it to operating income.  And not on a "per share" basis.

 

I won't do the work for you. But here is a hint. Compare the products IBM sold in 2000 to the products sold in 2014.

 

This is the best annual report cover I have ever seen:

ftp://public.dhe.ibm.com/annualreport/2000/pdf/2000_IBM_AR.pdf

 

Current IBM sure could learn a lot from old IBM.

 

 

 

[arcube]

 

Multiple is depressed because the market believes IBM is in secular decline because of AWS. Current performance of the business reinforces that perception. End of story. In 5 years, we'll know for sure.

 

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I want to have a healthy debate on IBM, but I just kill brain cells having the same debate ten times because people are too lazy to read the whole thread. I banned myself from VRX for this reason. Time for another ban.

 

I am not really sure if the market is just thinking that the decline is because of AWS. See attached. IBM had a huge advantage in all these product lines over the years. A lot of these are used in the IT and Internet Infrastructure (growing industries), yet they seem to be going nowhere. I am not sure if there is a currency impact in there but this is scary. IBM should grow way faster in this segment to stay relevant. Your perspectives are much appreciated on this and hopefully you return back to the thread to add important aspects to this discussion. Kind regards.

[KCLarkin]

For some perspective, in 2008 when IBM was busy purchasing those shares, one of its competitors was aggressively investing in nascent cloud initiatives and today it is leading that market by a mile, while IBM is still thinking about playing catch up there despite their billions in R&D investments each year.

 

The economics of "cloud" are terrible, relative to legacy IT. That is why none of the legacy vendors were early. Would Oracle rather sell upfront software licenses or buy massive data centres and bill month-to-month? This is the classic "innovators dilemna".

 

For Amazon, the economics of cloud are probably better than for their ecommerce business. So their investment was rational.

[Picasso]

Where is the return on that spend?  Now add up the following several years up until today and compare it to operating income.  And not on a "per share" basis.

 

I won't do the work for you. But here is a hint. Compare the products IBM sold in 2000 to the products sold in 2014.

 

This is the best annual report cover I have ever seen:

ftp://public.dhe.ibm.com/annualreport/2000/pdf/2000_IBM_AR.pdf

 

Current IBM sure could learn a lot from old IBM.

 

I understand the difference in IBM today versus 2000.  But when you're spending hundreds of billions you should be seeing a better return on investment by now, no?  EPS should be going up from the core business showing solid returns on invested capital. 

 

This is literally the opposite of what Buffett says to avoid: a business that requires massive amounts of capital to produce small incremental improvements in earnings.

 

It's totally fine that they've spent all that capital but I really have to wonder what there is to show for it.  Maybe I'm thinking about IBM in the wrong way, but it seems like other businesses are having an easier time getting better returns on much smaller amounts of capital deployed.  That's why IBM trades for 10x net income and all these other stocks trade at multiples of revenue. 

[petey2720]

I hope not to distract from the discussion, but my thinking is that Buffett looks at where his subs spend money:

 

http://www.computerworld.com/article/2576728/it-outsourcing/ibm--bnsf-ink-10-year-outsourcing-deal.html

[KCLarkin]

I am not really sure if the market is just thinking that the decline is because of AWS. See attached. IBM had a huge advantage in all these product lines over the years. A lot of these are used in the IT and Internet Infrastructure (growing industries), yet they seem to be going nowhere. I am not sure if there is a currency impact in there but this is scary. IBM should grow way faster in this segment to stay relevant. Your perspectives are much appreciated on this and hopefully you return back to the thread to add important aspects to this discussion. Kind regards.

 

This is an oversimplification, but you could say multiple is compressing due to secular concerns and estimates are dropping due to execution issues. This is a double whammy of misery.

 

Part of the narrative is that you don't need middleware once you move to the cloud. But as I mentioned, IBM's execution is really bad right now. So it is not clear if this is a temporary problem.

 

IBM claims they are being more flexible in their licensing with their customers. But this could be indirect pricing pressure from the cloud. This could play out like SAP or ORCL where you have temporary headwinds as you adapt to less attractive economics but then stabilize.

 

You also have the system x divestiture and macro headwinds. A whole world of hurt. But the IBM story only works if the software business is growing so you are looking in the right spot.

[KCLarkin]

Where is the return on that spend?  Now add up the following several years up until today and compare it to operating income.  And not on a "per share" basis.

 

I won't do the work for you. But here is a hint. Compare the products IBM sold in 2000 to the products sold in 2014.

 

This is the best annual report cover I have ever seen:

ftp://public.dhe.ibm.com/annualreport/2000/pdf/2000_IBM_AR.pdf

 

Current IBM sure could learn a lot from old IBM.

 

I understand the difference in IBM today versus 2000.  But when you're spending hundreds of billions you should be seeing a better return on investment by now, no?  EPS should be going up from the core business showing solid returns on invested capital. 

 

This is literally the opposite of what Buffett says to avoid: a business that requires massive amounts of capital to produce small incremental improvements in earnings.

 

It's totally fine that they've spent all that capital but I really have to wonder what there is to show for it.  Maybe I'm thinking about IBM in the wrong way, but it seems like other businesses are having an easier time getting better returns on much smaller amounts of capital deployed.  That's why IBM trades for 10x net income and all these other stocks trade at multiples of revenue.

 

Well, it would be interesting to look at FCF in 2010 versus 2000. Then look at how much cash was returned via buybacks and dividends in the meantime. Finally, compare to shareholder equity in 2000. You might see what they have to show for it.

[dwy000]

Where is the return on that spend?  Now add up the following several years up until today and compare it to operating income.  And not on a "per share" basis.

 

I won't do the work for you. But here is a hint. Compare the products IBM sold in 2000 to the products sold in 2014.

 

This is the best annual report cover I have ever seen:

ftp://public.dhe.ibm.com/annualreport/2000/pdf/2000_IBM_AR.pdf

 

Current IBM sure could learn a lot from old IBM.

 

I understand the difference in IBM today versus 2000.  But when you're spending hundreds of billions you should be seeing a better return on investment by now, no?  EPS should be going up from the core business showing solid returns on invested capital. 

 

This is literally the opposite of what Buffett says to avoid: a business that requires massive amounts of capital to produce small incremental improvements in earnings.

 

It's totally fine that they've spent all that capital but I really have to wonder what there is to show for it.  Maybe I'm thinking about IBM in the wrong way, but it seems like other businesses are having an easier time getting better returns on much smaller amounts of capital deployed.  That's why IBM trades for 10x net income and all these other stocks trade at multiples of revenue.

 

Well, it would be interesting to look at FCF in 2010 versus 2000. Then look at how much cash was returned via buybacks and dividends in the meantime. Finally, compare to shareholder equity in 2000. You might see what they have to show for it.

 

Even if you consider the $8-9BN they spend per year on Capex and R&D as "maintenance spend", that supports some $21-22BN+ of free cash flow before maintenance spend.  That's pretty impressive off of $90BN of revenues.

[kevin4u2]

From 2000-2008, they spent $110B on CapEx, Acquisitions, and R&D.

 

Where is the return on that spend?  Now add up the following several years up until today and compare it to operating income.  And not on a "per share" basis.

 

That's a big reason why the shares are flat lining.

 

I wrote this earlier this year, but I think its worth repeating. 

 

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 25%

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? Answer 5.5%. Net Profit Margin? 0%. Return on capital? 0%.  Why does Amazon get a pass?  Why is nobody complaining about amazon's returns on their investments?.  What is Amazon's FCF yield?

 

IBM has spent less on CAPEX than depreciation and has doubled Net Income over the past 10 years.  That should tell you something about the returns they have achieved on that capital.  It's absolutely huge.  What business can spend zero incremental capex over ten years and double net income?  A company that is focused on returns not growth at all costs.  They are exceptional capital allocators.  Return on capital has doubled and ROE is ridiculous.  The earn an absolutely absurd amount on capital spent.

 

This thread is hilarious to read.  A lot of naysayers and tire kickers but rarely something that adds to the discussion.  Not many people have taken the time to "look under the hood" and see what is going on at IBM or listen to the conference calls.  Oh well.  I also fail to see what everything has to be measured on an "absolute basis".  I don't measure nor care about absolute increases in revenue or net income if it is flat or declining on a per share basis.

 

Let me put it a different way (Invert, always invert)... Owning a company with zero revenue growth but doubles margins and net income, as IBM has done over the past 10 years, is equivalent to owning a company that doubles revenue but has zero margin growth.  The net result (to the bottom line) is the same in the eyes of the owner.