IBM - International Business Machines

[no_free_lunch]

Palantir,

 

When we are talking growth, why would you add the debt on, that doesn't make sense to me.  The interest on the debt is already taken into account in calculating FCF, so it's not relevant. 

 

Given that it's 12.5 / 190 or 6.5%.  So to get to 10% you need 3.5% earnings growth.  2% inflation, 1.5% organic and you're there.  Keep in mind that over the past 10 years, the net income has been growing at 7-8%, including 5 years of recessionary period.  If they did 7% again, that would be 13.5% per year which is aggressive and I wouldn't bet on but that's just using actual past results.

 

Now the 3.5% is hardly what is actually going to happen, it will be higher or lower but it certainly isn't an unreasonable target given past history and all the various reasons I've mentioned in the past.

 

If the market ever buys into my theory, which they likely will IF IBM can start hitting their numbers, their would have to be a significant repricing given where interest rates are today.  I mean why buy 25 year bonds at 3.5% when you can get a solid blue chip and make 10%?

[JBird]

to credit value accretion from buybacks is double counting.

 

Say an investment holding company has 100 shares. $1000 in cash, no other assets, and zero liabilities. Per-intrinsic value is $10. Now the company repurchases 50 shares for $5 per-share. 50 shares remain. $750 in cash, still no liabilities. Per-share intrinsic is now $15 ($750/50). If the per-share value accretion was not caused by the buyback, what caused it?

[Palantir]

Palantir,

 

When we are talking growth, why would you add the debt on, that doesn't make sense to me.  The interest on the debt is already taken into account in calculating FCF, so it's not relevant. 

 

Given that it's 12.5 / 190 or 6.5%.  So to get to 10% you need 3.5% earnings growth.  2% inflation, 1.5% organic and you're there.  Keep in mind that over the past 10 years, the net income has been growing at 7-8%, including 5 years of recessionary period.  If they did 7% again, that would be 13.5% per year which is aggressive and I wouldn't bet on but that's just using actual past results.

 

Now the 3.5% is hardly what is actually going to happen, it will be higher or lower but it certainly isn't an unreasonable target given past history and all the various reasons I've mentioned in the past.

 

If the market ever buys into my theory, which they likely will IF IBM can start hitting their numbers, their would have to be a significant repricing given where interest rates are today.  I mean why buy 25 year bonds at 3.5% when you can get a solid blue chip and make 10%?

 

The debt is taken out because we're talking about flows to equity holders, and debt owners have a claim on the cash flows equal to principal + interest. (twacowfca: I saw your post, from what I read on their B/S, they have a liability, but I'll ignore the pension plan for now).

 

So we have 14B of FCF, and they use about 2-3B in acquisitions, like any other tech company, this is a serial acquirer, and acquisitions tend to be more like R&D+CapX, giving us 12.5B annually. Taking their 23B in net debt gives us an EV of 218. 12.5/218 = 5.7%.

 

Since we're talking real numbers, there is no need to add inflation. The real issue comes down to growth rate. Their historical growth rate has been 3%, but near term, they've been slower and you'll need an average growth rate of at least 4% to reach your 10% target, why do you think the firm is going to exceed its historical growth rate?

[Palantir]

to credit value accretion from buybacks is double counting.

 

Say an investment holding company has 100 shares. $1000 in cash, no other assets, and zero liabilities. Per-intrinsic value is $10. Now the company repurchases 50 shares for $5 per-share. 50 shares remain. $750 in cash, still no liabilities. Per-share intrinsic is now $15 ($750/50). If the per-share value accretion was not caused by the buyback, what caused it?

 

I never said value accretion is not caused by a buyback. The issue is where do you count it? When you're valuing cash flows, you only value actual cash flows, and when you repurchase shares, you're giving up cash flow out of the current yield, otherwise you will double count the same flow, especially in a firm that is perpetually repurchasing shares.

[no_free_lunch]

Debt holders can be put off indefinitely (more or less), so I wouldn't include them.  They get their interest and that is already taken into account by FCF.  So 6.5% yield.

 

Who said we are talking real numbers?  The original post was that buffet wanted 10%, only you came up with the real concept.  I am talking nominal numbers.  Bonds are in nominal terms and that is what we are comparing to.  Don't start changing definitions to meet your argument.

 

Their historical growth rate in earnings has been 8% nominally over the past 10 years.  16.6B in 2012 vs 7.6B in 2003.

 

 

[Palantir]

Debt holders still have a claim to that cash flow. If you can arbitrarily add a 2% inflation rate to your valuation, then I guess all my investments are growing 2% faster than I thought. And given that we were talking about free cash flow? Taking net of acquisitions (outflow)...

 

 

Free Cash Flow in 07 = 10.7B

Free Cash FLow in 12 = 12.486 B

 

= 3%

 

Given that the market seems to think IBM is slowing, why do you feel it will grow faster?

[no_free_lunch]

They are heavily focused overseas and BRIC & Europe are experiencing slowdowns.  A return to growth in these areas should translate to growth in IBM.

[hyten1]

palantir,

 

not sure why you use real terms, bond rates are in nominal terms, and my annualized return % that i keep track of to determine if investing on my own is worth the time and effort are in nominal terms :)

 

maybe you adjust everything to take into account inflation, i don't, i do however compare it to risk free treasury rates (and other investments) as a means to determine the amount of return i need for the specific risk that i'll be taking.

 

if you adjust for inflation on everything then its a wash.

 

but if goog announced that they grew earnings by 20% that is nominal terms no? i don't think they adjust it for inflation.

 

as for debt holder, yes they have a claim on cash flow, but isn't that already taken care  of in the FCF number? that number is after debt interest payment no?

 

maybe you have a stricter metric that you look at EV/FCF, i would assume if that is the case than many companies metric will be adjusted as well which will most likely be a wash (obviously company without much debt will have better numbers).

 

typically its EV/EDIT or EV/EBITDA i guess you like a stricter metric EV/FCF which is all good

 

 

hy

 

Debt holders still have a claim to that cash flow. If you can arbitrarily add a 2% inflation rate to your valuation, then I guess all my investments are growing 2% faster than I thought. And given that we were talking about free cash flow? Taking net of acquisitions (outflow)...

 

 

Free Cash Flow in 07 = 10.7B

Free Cash FLow in 12 = 12.486 B

 

= 3%

 

Given that the market seems to think IBM is slowing, why do you feel it will grow faster?

[Palantir]

Well I hope you are right, because then my investments are worth more than I thought they were. :)

[skanjete]

The investments in takeovers of IBM are in my view only partly expansion and also partly replacement investments, because of the nature of their existing business. Margins on their existing businesses tend to lower over the years, so they reinvest in acquiring new, more promising businesses. So for considering free cash flow one has to take this element into account. Part of the takeovers have to be substracted from the cash flow for calculating the free cash flow. The exact number of course is difficult to calculate but can be deducted from the long term track record (cfr. lower).

 

In my view, the buy backs have to be considered as a reinvestment in the business by the shareholders, but don't affect free cash flow. Someone who sells his shares to the company isn't a shareholder anymore so his view doesn't count anymore for a long term consideration.

A shareholder who doesn't sell, buys a proportionnally larger stake in the company. That's nothing else than an investment.

Buy backs are thus a very special type of investment, because it's an investment one can be very opportunistically with. It's not that it's a machine that has to be replaced or else the business stops. One has an great flexibility with the way buy back money can be spend. Moreover buy backs are always expansion investments and no capital investments.

So they don't affect free cash flow.

 

The sum of this all for IBM is that the combined effect of reinvestments, acquisitions and buy back have led to an increase of the value a share.

Over the last 20 years, net profit, cash flow and free cash flow per share have all increased at a rate of approximately 10%/year. Adding the dividends paid out gives you the economic reality.

 

So if one thinks that IBM can continue this over the coming decade, one can make an estimate of the return one can expect from an IBM share. A dividend of 2%, and growing at a rate of say 10%, and a growth of principal of 10%/year.

Considered this way, and in view of their competitive advantages, it's easy to understand way Buffett bought.

[Guest Dazel]

 

http://www.forbes.com/sites/tomgroenfeldt/2013/01/14/ibms-20th-year-of-record-u-s-patents-leads-with-cognitive-computing/2/

 

 

Patents worth?

 

 

Analytics is going relatively unnoticed and it growing very quickly...great margin business.

 

Dazel

[Charlie]

more share repurchases  :)

 

http://finance.yahoo.com/news/ibm-board-approves-quarterly-cash-160400212.html

[Yours Truly]

more share repurchases  :)

 

http://finance.yahoo.com/news/ibm-board-approves-quarterly-cash-160400212.html

 

Like a good cannibal that it is :)

 

Management will work hard to obtain that EPS target for 2015

[argonaut]

At least they are buying back the stock here and not at the very top : ) Barring more overseas challenges; they will meet their 2015 plan.

[tombgrt]

Wish I bought more leaps! ; (

[Palantir]

IBM is the only large cap company that has an over funded pension plan, medical plan

etc. for retirees.  :)

 

I forgot about this, do you have a reference for this?

[fareastwarriors]

http://www.nytimes.com/2013/11/14/technology/ibm-to-announce-more-powerful-watson-via-the-internet.html?src=busln

 

IBM to Announce More Powerful Watson via the Internet

[fareastwarriors]

http://www.businessweek.com/articles/2013-11-15/ibm-faces-a-crisis-in-the-cloud#r=most popular

 

IBM Faces a Crisis In the Cloud

[Palantir]

IBM is the only large cap company that has an over funded pension plan, medical plan

etc. for retirees.  :)

 

I forgot about this, do you have a reference for this?

 

 

Bump

[Phaceliacapital]

My BB terminal data shows that it is underfunded..

[vinod1]

 

IBM is the only large cap company that has an over funded pension plan, medical plan

etc. for retirees.  :)

 

twacowfca,

 

I did not notice this comment. Thanks to Palantir for bringing this up.

 

Over the last 12 years from 2001 to 2012, IBM has contributed about $39 billion to pension funds ("Retirement"), of which only $17 billion has hit the income statement. So IBM had to contribute about $22 billion over this 12 year period, that does not show up as an expense. Granted this greatly reduced the underfunding, but it still has a pension deficit of about $22 billion. Expected returns of 8%, given the stock market and bond market valuations, are unlikely to be realized. So I am expecting about $1 billion in pension contributions on an annual basis to cover the underfunding.

 

Only if interest rates rise, do I see them not having to make these additional contributions. They are using about 4% as the discount rate and it is pretty much in line with other companies as well.

 

I had a hard time trying to reconcile all the retirement numbers from the footnotes and would really appreciate if you could shed any light on why you think IBM has an overfunded retirement plan.

 

Thanks

 

Vinod

[valueinvesting101]

 

 

http://www.bloomberg.com/news/2013-11-22/druckenmiller-shorting-ibm-in-bet-cloud-computing-to-win.html

[Guest Dazel]

 

 

Got lucky here sold at $185 level for a quick 6% to buy bargains elsewhere...would love to be able to be back here again...hedge funds can move stocks short term but Buffett will win here in the long run...they are doing him a favor knocking the shares down.

 

Dazel

[no_free_lunch]

I work in IT.  I've been following the cloud computing thing for years.  In my opinion it is vastly over-rated, a lot of hype.  It solves issues around installation and maintenance of software, which in my opinion are not even real issues nowadays.  It does nothing to solve the real issue with software that most vendor's solutions do not do exactly what you want and require customization.  In fact, it actually makes customization more difficult in many cases.  So, in areas where customization is not an issue or where the problem space is so well defined that they can solve it (think CRM), cloud will take market share, everywhere else (and everywhere else is HUGE) I just don't see it.  You are still going to need software consultants to help out in understanding the needs, integrating systems and architecting solutions for most business software. 

 

I will also point out that cloud is actually more profitable, generally, than non-cloud solutions.  At least in the cases I have looked at it.  So as IBM goes into the space, even if they give market share, they may be able to hold profits level.

 

EDIT: Now that I took the time to read the actual post from drucenmiller, I realize that he is talking more about amazon and platform/infrastructure as a service.  In that sense, it's still a bit overhyped but I do like amazon's offerings and it will definitely take strong market share.  The other component to cloud computing is software as a service which is what I was referring to.

[ItsAValueTrap]

Could Druckenmiller be missing the point?

 

IBM's strength is its ability to integrate different software and hardware together.  They provide IT services for large organizations (who wish to outsource their IT).  Yes IBM develops software and makes hardware but that isn't where their competitive advantage lies.