IBM: Going To Take At Least Another Year To Turn The Battleship

IBM reported its December quarter and full year 2015 results after the close on Tuesday. While it hit the Street’s revenue estimate of $22.04 billion by generating $22.06 billion this was down 8.5% year over year and down 2% in constant currency. For the year the company generated $81.7 billion in revenue, down a reported 12% and down 1% in constant currency and adjusted for divested businesses.

IBM reported $4.84 in operating or non-GAAP EPS which was above the Street’s $4.81 expectation but down 17% year over year. A lower than expected tax rate helped by as much as $0.34 per share, which means the company would have materially missed analyst’s earnings estimates.

Guidance was much lower then expected

Going into the quarter the average sell-side projection for IBM’s 2016 EPS was $15.00 (vs. what turned out to be $14.92 for 2015). I had written after the company reported its September quarter results that investors should "Watch Out For Ugly 2016 Guidance In January". Unfortunately I was correct.

Steve Milunovich at UBS thought that IBM’s guidance could be below the $15 and that it could disappoint. His scenarios were Bearish guidance would be $13.75 to $14.50, Bullish would be $14.50 to $15.50 and most likely it would be between $14 to $15. IBM’s guidance of "at least $13.50" didn’t even include the low-end of Milunovich’s forecast. One point to keep in mind is that the company benefited by about $1 per share in currency hedges in 2015 that don’t repeat in 2016.

Free cash flow is also lower than expected

Many IBM investors are looking for the company to generate cash to at least pay if not increase its dividend (currently has a 4% yield) and buyback shares. In 2015 IBM generated $13.1 billion in free cash flow but the outlook is for it to decrease to a range of $11 to $12 billion in 2016. With a market cap of about $117 billion based on the after-markets stock price of $122 the shares are trading between a 9.8x and 10.6x free cash flow to market cap ratio.

Strategic Initiatives are growing well but legacy business is taking it on the chin

IBM’s Strategic Initiatives businesses generated about $29 billion in revenue during 2015 and grew a very solid 26% year over year. While they are 35% of IBM’s total revenue they are still not large enough to offset the 24% drop in the company’s $53 billion legacy businesses.

Overall it appears that IBM is still in the early to maybe mid-stages of a multi-year turnaround. In running a quick analysis through 2017 the company’s Strategic Initiatives could get to half of the company’s revenue but IBM will have to slow the decline of its legacy businesses from 24% down to 15% in 2016 and 12% in 2017 just to have zero revenue growth. Currency, acquisitions and divestitures could impact this outlook but it appears at first glance that it will be difficult for IBM to show meaningful revenue growth for the next few years.

Still bearish on IBM shares

I had been negative on IBM shares throughout 2015 after its March (IBM Is Dead Money), June (IBM’s Shares Should Be Avoided Until A Turnaround Results Are Visible) and September 2015 (IBM Losing More Credibility: Watch Out For Ugly 2016 Guidance In January) quarters. Maybe sentiment and expectations have gotten low enough for the shares to rebound but it will probably take at least a few quarters of management maintaining if not raising its “at least $13.50” in EPS for investors to have confidence in management again.