IBM Has Significant Problems

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- By Stepan Lavrouk

Shares of IBM (IBM) have been significantly depressed over the last five years. Ever since the stock peaked at around $215 per share in 2013, the price has slid, with a significant amount of volatility, to where it currently trades at $140 per share. What has been the driving factor behind this move, and is IBM now undervalued?


Business overview

The stock is currently trading at a price-earnings ratio of 10.03, a comparatively low figure for the sector. IBM has spent the last few years expanding its operations through acquisitions, focusing on what it calls its "strategic imperatives" -- a representation of management's long-term view of where the tech sector is heading. Chief Financial Officer Jim Kavanaugh summed these up on the latest earnings call:


"Nearly half of our revenue is aligned to the strategic imperatives, which represent the emerging, high-value, high-growth segments in our industry. This also reflects a major portfolio shift for IBM, driven as we discussed at our investor webcast in March, by major shifts in our capital allocation and investment strategy. Those shifts reflect our vision of what clients would value in a rapidly reordering IT industry, driven by cloud, data and AI, and that is innovative technology in key emerging areas, the expertise to apply that technology in industry-specific processes and workflows, and a commitment that their enterprise data would be handled responsibly."



IBM is in the process of acquiring Red Hat, a distributor of open-source technology used in server computers and data centers. The acquisition should be completed in the second half of 2019, although there are now signs that the merger may be delayed . Management hopes that this deal, the third largest in the history of U.S. tech, will boost revenue growth in its cloud computing segment.

Significant challenges remain

The problem for IBM is a lack of revenue growth in any significant business segment, as recent expansion activities have failed to deliver. There is a class of tech investors, on both the institutional and retail side, that invest primarily in growth, and as there is no growth on the cards for IBM, they have avoided the stock. There are also fears that the company may have overpaid for Red Hat by purchasing stock at $190 per share, when they were trading at $117 on the last trading day before the deal was announced.

IBM wants to be the top player in the hybrid cloud market -- a kind of midpoint between private cloud centers and public ones like Microsoft (MSFT)'s Azure and Amazon (AMZN)'s Amazon Web Services. The problem is that as the public cloud computing becomes more and more accessible, the need for the hybrid model may disappear.

Summary

With all that said, IBM pays a solid dividend of 4.6% and is cheaply priced relative to sector rivals. However, the reasons for this cheap price may be too significant to ignore. The company is not attractive to either growth investors or investors focused on the competitive landscape of the industry. Until revenue picks up again, it may be better to give this stock a miss.

Disclosure: The author owns no stocks mentioned.

This article first appeared on GuruFocus.


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