The Death of IBM

The death of IBM

If you were asked to invest in a company with declining revenue, collapsing earnings and a company that has pretty much abandoned next years earnings forecast, would you invest in it? No? What if I told that the board of directors has a solution to this problem – which is repeated attrition and buying its own stock. Still no? Welcome to the life of (and possibly the death of IBM?) one of the oldest and largest tech companies in the world – International Business Machines (IBM).

The Tech Sector

As someone working in the tech industry, I find IBM to be a dinosaur. They are stuck in the old ways and are too sluggish to move forward. And especially in an industry where things move fast, even if you stand still – you are considered moving backward. I have written in the past about companies dying and go through a life cycle just like individuals. Nothing really lasts forever. Could this be the beginning of the end of IBM?

Technologically, IBM is just resting on the old accolades. They have already sold their server and desktop business to Lenovo and now selling their chip business to Globalfoundaries (for which IBM is paying $1.5B to take it off its hands). They still lead in a few fields like mainframes/supercomputers and AI, but who knows how long that’ll last (Google and Microsoft have some pretty fantastic/smart teams in their AI divisions although the target market slightly different – but still look out for competition there).

The Death of IBM

This is a company that has its third quarter profits fall 99%!! And pretty much abandoned its 2015 earnings forecast. That is just unacceptable for a company with a heritage like IBM. And what is the response to that? Board is being asked to authorize more buybacks! Over the last few quarters, they have unveiled some pretty horrific numbers from declining revenues to razor thin margins and have resorted to financial engineering like buybacks to prop up their numbers. Buyback programs like IBM’s are the reason why I hate the buyback programs.

Keep in mind that IBM has the resources to turn things around – which could result in a great contrarian play. I for one would never invest in IBM under the current conditions.

Alternatives

All tech stocks in the DJIA have some rainy days ahead. The three tech components are Cisco Systems (CSCO), Intel Corp (INTC), International Business Machines (IBM). Cisco is facing headwinds from all sorts of places – such as dropping revenue from China and other overseas clients, forex conversion hits due to a strong dollar, competition from startups etc. Intel has also seen its fair share of problems having completely missed the boat on mobile chipsets and companies like Qualcomm Inc (QCOM) have a brighter future going forward. And so far IBM has seen one too many disappointing quarters. Last week, I also opened a small starter position in Apple Inc (AAPL). I am speculating here, but with the rumors of Apple getting introduced into the DJIA index after the stock split earlier this year, I think IBM is one that could get kicked out of the index.

Do you invest in IBM? What are your thoughts on the stock?

Full disclosure: Long AAPL, QCOM. My full list of holdings is available here.

26 thoughts on “The Death of IBM

  1. R2R,

    as you know I am a shareholder of IBM. Obviously we disagree on some points, but I can understand your view on things. Recent developments have not been stellar to say the least.
    However, with the old tech stocks I always wonder if the possible struggles are not already priced in. IBM seems cheap to me, so I am holding on to my position in hope of dividends increases and buybacks.

    Thanks for sharing

    • GI,
      IBM has the resources to turn things around, but it needs a radical change from the current course. Most of the fundamentals are out of whack. Look at the numbers like book value, cash avail etc. The company has been piling on debt like theres no tomorrow. I agree that this is a good time to take on debt with the low interest rate environments, but the current debt limit is too high (total debt = $46B, debt/equity = 2.67-3.1 depending on which source to look at) I read somewhere that $14B of that debt is due in the next four years (but havent double checked it on my own). So, theres some headwinds ahead, to put it lightly.

      Good luck,
      R2R

  2. R2R,
    I do not own IBM. Instead I opened a position in ACN recently. I prefer it’s awesome balance sheet to IBM. It’s also leaner, and relies on services more than IBM which needs to sell hardware and software. If I were to take a position in IBM, I need to do a lot more research. Curious what Buffet does here. My guess is he holds.
    -RBD

    • I havent checked ACN numbers deeply, but I had quickly taken a peek at some of the fundamentals a few months ago and it looked healthy enough. I think ACN is a better run company – as you said, leaner and more service oriented.
      Yeah the whole Buffett story surprised me that he picked IBM of all the tech companies. My guess is also that he’ll probably hold.

      cheers
      R2R

  3. R2R,

    I think IBM is more of a sleeping lion than a dead one. I do think the company has some soul searching to do and will have to make a lot of painful changes going forward. I remember when HPQ and Intel were thought to be dead a couple of years ago, and the companies have been great turnaround stories. I still have faith in IBM and don’t have a problem adding to my position, just as I have done today.

    MDP

    • MDP,
      I wouldnt really call HPQ a success story….although the stock would say otherwise. The market seems to like whatever they are doing, but Im not a fan of the management at HPQ either. The company has made some terrible decisions in the past and is starting to correct its course now. The split is definitely a good direction.
      Re: IBM – I hope your investment works out for you. IBM’s current path is disastrous and will need some great leadership to turn things around.

      Best wishes
      R2R

  4. I do not own IBM but I don’t think the company is dead. IBM has been around for a long time and has transformed over the years. I went to a historical museum this summer and found an IBM device in the museum. The device was made in the late 1800s/early 1900s and was a cheese cutting machine with a calculator built-in. This device demonstrated how much IBM has changed over the years.

    • Theres no denying that IBM has a great history and heritage. But resting on past accolades does nothing for the future prospects. If the company isnt innovating and driving into the next era, esp in the tech sector, they will be left in the dust. It will simply turn into a has-been. The current course is headed exactly into that direction. The exec pay packages are aligned with the EPS performance – and thats exactly what they are doing. Raising cash by issuing bonds (which is ok, as long as you invest/innovate) whilst already holding massive amounts of debt ($46B at last count, of which $14B is due in 4 years I heard somewhere) and what do the execs decide? Buy its own stock in order to raise those EPS numbers. Pathetic.

      R2R

  5. I am guessing the same thing that IBM will be kicked out and APPL will be added to the DOW. I wrote a small piece of article yesterday upon hearing their result and how they are abandoning the target $20 EPS for 2015.
    You wrote: “Keep in mind that IBM has the resources to turn things around – which could result in a great contrarian play. I for one would never invest in IBM under the current conditions.” I agree, if investors are optimistic about this company, this can be a great entry price for them. But for me, I will be waiting until they I see sign of brighter future. Great article!

    • Yup, this is the whole classic “be greedy when others are fearful”. Its a great time to pick up shares of IBM if you believe that the company will turn around and will be a good long term hold. I dont believe in the management one bit. The execs are simply lining their pockets with the asinine buyback program while piling on debt. When the debt is due, those execs will be long gone.

      Thanks for stopping by and the comment. I’ll check out your post.
      R2R

  6. IBM scares me as an investment. It screams “old school” “mature” and “blue chip” but is it really? They survived one complete change (hardware to services) what are they going to do now? Seems like their economic moat is slowly evaporating, doesn’t it?

    • Yup, Like I said in the article, I wont be surprised if they get kicked out of DJIA to include AAPL instead. They’ve managed to survive for a very long time and have had some really shady past (including working with the nazis), so its still early to write them off. But their strategy needs to change.

      R2R

  7. R2R,

    I won’t speak to the totality of the article, only because I thought you started it off incorrectly:

    “If you were asked to invest in a company with declining revenue, collapsing earnings..”

    I just wrote up a fresh article on IBM myself, and went over the numbers. And here they are:

    Earnings have grown at a compound annual rate of 13.08% over the last decade. I actually wrote about Coca-Cola in the same article, and IBM handily trumped Coca-Cola in EPS growth over this time frame. What exactly is “collapsing” about that? The 3Q wasn’t great, but they’re guiding for $15.97 to $16.30 in EPS for this fiscal year. That’s approximately a 7% improvement on last year. Again, “collapsing”? I think that’s just way off base.

    I agree that the company needs to grow revenue at some point, because there’s only so much growing profit you can squeeze out of the same top line dollar through cost savings, increasing margins, and share buybacks.

    However, “declining revenue” is again incorrect:

    Revenue GREW from a bit over $96 billion to almost $100 billion over this time frame. Not a lot of growth, I’ll give you that. But it’s not declining either.

    Revenue is probably going to further contract from here, but it’s important to have some context. Per the call:

    “In the near term, our revenue will be down, not surprising since the three divestitures this year represent about $7 billion of revenue with pretax losses of about $500 million. So clearly we’ll have improved margin profile.”

    Getting rid of $7 billion of revenue that was losing you money is a smart business decision, in my view. I don’t think anyone intelligent would take on $7 billion worth of business if they knew it was going to lose them money.

    Just my take on things. I agree they need to improve, but I think it’s important to provide context and use proper language. Collapsing earnings is just not what we have here, as much as I appreciate hyperbole.

    Best regards!

    • Hi DM,
      I appreciate the strong stance you take and the feedback.

      Having said that, I still contend that the revenues are declining. If you go back far enough, you will see them increasing, but looking a bit more closer in history – they are declining. Here are the detailed numbers (all data here in this comment from Morningstar) for total revenue: 2008=$103B, 2009=$95B, 2010=$99B, 2011=$106B, 2012=$104B, 2013=$99B, ttm=$98B. So, from the looks of it, they peaked in 2011 and have continued declining since.

      Re the earnings, the company has not been very kind to the shareholders by not giving any indication on whats happening. Before formal reports, public companies need to give an indication to shareholders as to whats upcoming – not simply drop the bomb on them on a formal release that the earnings have dropped from most expected growth areas. While this is not a written rule (and they cant be on hook for it), its expected from most companies. More importantly, look at where those positive earnings are coming from. The company is piling on debt to prop up those numbers. They have managed to croak out positive EPS numbers to please the street year after year by taking on debt and buying their own stock. When the cash exists and the resources are available, buybacks make sense. This is one company whos buyback program I do not approve of. The share count has continued to decrease YoY for the last 10 years, while the debt has continued to increase. This is the equivalent of an individual borrowing money to buy expensive clothes and cars to paint an image of success. That does not sound like a healthy company to me.

      Best wishes
      R2R

  8. Andy F says:

    “Be greedy when others are fearful”

    I think that quote gets over used when a stock simply sells off. I think Buffett means when certain situations like recessions or a stock drops due to a CEO leaving or a blip in company’s image. He’s telling you to buy in those moments. He’s also telling you that the company’s core business hasn’t been negatively affected. It’s people selling shares that has not much to do with a company’s business.

    Now on IBM. This is Buffett’s single tech stock. He doesn’t dabble too much into this industry as he doesn’t have much of an understanding. No question to his investing ability, however he is not always right (see his recent Tesco investment). Nor am I right.

    I am too in the tech sector. One thing people forget it is that the tech sector moves at a pace much more rapid than any other sector. Companies get build and die faster than any other. Cost of business is much cheaper and VCs find anything and everything to back with capital. That being said, IBM has to re-innovate itself. Otherwise, it will be buying back more shares with more debt. Once rates rise, that debt will have impact on its balance sheet. As revenues decline, so will profits. IBM is trying to get into the cloud business. So is every other tech company out there. I just don’t see IBM lasting as long as most think. In my opinion, in 10-20 years it will be broken into different parts because investors will want the most profitable business to prosper (eg. PayPal spun off from Ebay). The rest will be sold off. The only bet on this company is its cloud play and partnership with Apple in enterprise. Lets see what happens.

    • Completely agree with you, Andy. The reason why there arent so many dividend aristocrats in the tech sector is simply because of that reason….companies do not exist or arent stable enough to last that long. There is immense growth and once that stalls, companies like HP (and now we also see it with IBM) get broken up and sold to separate businesses. It’ll be interesting to see where IBM will go from here – I will be following along.

      Thanks for stopping by and the comment
      R2R

  9. Nice critique. I agree that IBM is getting old, but I’m just not convinced it’s the end of the line for them. It was definitely a good thing to remove that earnings goal for 2015, since it forces them to work toward some arbitrary metric without caring as to how well it does so. Slow and steady is worth it. And the fact their selling their unprofitable hardware is a good sign, since it shows they know what’s holding them back and are fixing it. Maybe we’ll agree to disagree here, but I think it’s worth investing in IBM.

    • Thanks for stopping by and the input, DD.
      Yes, I think we can agree to disagree. I am not comfortable with what IBM is doing and would not invest in it. I will be looking elsewhere for my investment $.

      Best wishes
      R2R

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