IBM: A stumbling giant quietly regains its stride
It might be hard to believe but after a long, decidedly disappointing decline, International Business Machines (IBM) is breaking away, finally, to the upside.
It sure has been a struggle for what was once the world’s largest technology company. IBM degenerated in recent years to become an old clunker in a fast-moving industry. It tried many times to recover and pick itself up, but it seemed exhausted and out of fresh ideas since 2013, when the stock crested at a high of $215.90 a share.
But now, several close watchers of Big Blue say things are looking much more spirited for the computing pioneer, and it may truly be emerging as the old guard’s Comeback Kid.
One important factor that lends support to this scenario is IBM’s previously long-languishing stock, which has lately been outrunning the price targets of the most optimistic IBM bulls.
Kathy L. Huberty, equity analyst at Morgan Stanley, was one of the Wall Street analysts who came out early with a clearly bullish forecast on IBM on Feb. 18, 2016, when she upgraded her rating on the stock to “overweight” from “equal-weight” and raised her price target to $140 from $135 a share. (Morgan Stanley does business with IBM.)
Guess what? The stock has already, quietly, exceeded that price, closing out the first quarter on Mar. 31, at $151.45. So, Huberty promptly raised her price target the same day to $168 a share — with a positive caveat that the most bullish scenario could take the stock way up to $195. IBM then started April with another move up of 0.7 percent, or $1.04, to $152.52, on Friday.
In her March 31 report, Huberty figured the stock is now riding on the back of strong Watson customer growth and more confidence in its full-year earnings estimate. “Watson is beginning to pay off,” she asserted, noting that after aggressive hiring and an estimated $5 billion in data acquisitions over the past two quarters, IBM is “beginning to show a path toward revenue monetization in Watson.”
She also noted the growing number of Watson customers, including Hilton Worldwide (HLT), Softbank, KPMG, Turner Broadcasting (TWX), Siemens and Honda (HMC), and she predicts they’ll double this year.
In an earlier report, Huberty observed that IBM’s “transformation into a more cloud and analytics focused business is currently under-appreciated, although new disclosures could build confidence.” IBM’s price “doesn’t reflect the ongoing transformation, with strategic imperatives, including cloud, data and engagement, now accounting for 35 per cent of the revenue and growing 26 per cent on a constant currency basis in 2015,” Huberty said. She added that she expects the “valuation disconnect to correct with new disclosures, stabilizing revenue trends this year, and improving free cash flow.”
Indeed, that disconnect is starting to correct itself. Huberty believes “a faster shift of investment dollars to growth areas in recent quarters” has positioned IBM to “benefit from a structural shift to application-oriented solutions from infrastructure-based ones.”
The Morgan Stanley analyst said, “IBM is coming up on renewals of large-customer enterprise license agreements in late 2016, which could further improve deferred income and, therefore, free-cash-flow trajectory.” Huberty thinks investors are finally starting to recognize IBM’s “competitive lead in Strategic Imperatives, particularly Watson.”
But she noted that despite the recent rise in IBM’s stock, a lot of negativity continues to hound the company, partly evidenced by the high short interest (bets that the shares will fall). However, such negativity could sometimes turn out to become a positive. Huberty pointed out that “the historically high short interest could set up for a stronger upward move in share price should IBM hit earnings expectations near-term.”
And over the medium term, “we believe increased traction of Watson, improving constant currency revenue growth and expanding free cash flow in 2017 will help further re-rate shares,” said Huberty.
Alan Farley of Investopedia, who headlined a recent report as “IBM Turning the Corner After a Long Decline,” noted that Big Blue has disappointed investors in recent years. But after relinquishing more than half of the gains posted since its 2008 bear market low, “things have improved in the first quarter of 2016, with a “sturdy bounce off downtrend lows and renewed optimism that investments in analytics, mobile, social media, security and cloud computing will pay off with higher revenues.”
Still an enormous company with a $145 billion market capitalization, IBM is the fourth-largest Dow industrials technology component behind Apple (AAPL), Microsoft (MSFT) and Intel (INTC). After a three-year downtrend, a silver lining has emerged, said Farley: “Long-term cycles raise odds that the decline is coming to an end.”
John Harrington, analyst at Blueshift Research and a veteran Wall Street researcher, noted that IBM has taken over AT&T’s (T) data centers and, at the same time, has become deeply integrated with Apple’s Swift programming language. “Such actions are meant to develop an extensive suite of enterprise software applications in order to lure IBM’s traditional customers to the Cloud and to enhanced services like Watson,” said Harrington in a recent report.
IBM now has the capability, said Harrington, to scale up to service levels that could place it in cloud computing’s top tier with Amazon’s (AMZN) Amazon Web Services and Microsoft’s Azure. IBM didn’t have the time, he added, to build out new data centers all over the world to move up into the race with Microsoft and Amazon.
Brian J. White, equity analyst at investment firm Drexel Hamilton, who rates IBM as a “buy” with a price target of $160 a share, notes that “after a tough few years,” Big Blue showed a “more confident tone” at its most recent meeting with analysts. He said Chief Financial Officer Martin Schroeder emphasized rising gross margin trends over the past decade as the company shifted to higher-value areas of the industry to better support its customers. As an example, Schroeder pointed out that IBM generated a gross margin of 36.5 per cent in 1999, which had jumped to 50 per cent in 2015.
The CFO also walked analysts through the company’s impressive long-term financial model. “If IBM can return to those financial metrics, we believe the stock will be meaningfully higher,” said White. With a corporate history dating back to 1911, noted White, IBM has undergone many transformations in its storied history that have allowed it to survive even the most difficult times.