International Business Machines Corporation

IBM has been undergoing a long transition during which its stock is where it was almost 8 years ago. Almost half of their revenues are categorized by what the company calls “Strategic Imperatives” which are emerging high value and high growth segments of their business.  They have exposure to many of the popular business trends such as AI, analytics, blockchain, security, and cloud.  Their results have been stabilizing and look to be improving.  Certainly IBM isn’t the fastest growing or sexiest name in technology but that reflects in their valuation; the company has a sound balance sheet and delivers meaningful free cash flow to pay dividends, repurchase shares, and repay debt. During this transition, the company has been focusing on cost efficiencies to driver operating leverage. Recently IBM announced an agreement to acquire Red Hat to focus on its cloud business, the company’s significant free cash flow can quickly repay the debt.  While I have been inclined to rather own other software companies such as Open Text and Adobe to IBM, I’m looking at IBM as being likely more attractive than cash due to its valuation, generally improving results, and attractive dividend yield.

 

Ests:     4Q19   1Q20   FY19    FY20

Revs    21.6b   18.5     77.0     79.4

EPS      4.68     2.15     12.80   13.29

 

P=139.17, div=6.28, yield=4.5%, D/C=76%, TTM EPS 12.81, P/E=11X, FY20 P/E= 10X

            

4Q19   4.71 vs 4.87 est 4.68 down from 4.72, FY19 adj EPS 12.81 vs 13.81 (-7%)

  • Jan 21, 2020, P=139.17, TTM EPS 12.81, P/E=11X, FY20 P/E= 10X

  • Revs +0.1% to 21.8bn, +3% ex divestitures and fx, adj GM 51.8% vs 49.5%, OM 23.2% vs 24%, OpInc -3.3%, adj EBT margin 21.6% vs 22.1%, EBT -6.6% due to interest expense

  • RHT normalized Revs +24% to 1.066bn, reported 573m, Cloud +21% ex divestitures and fx to 6.8bn, seeing acceleration in new RHT engagements. Doubled number of new services engagements leveraging RHT vs 3Q19, also doubled number of large RHT deals vs 3Q19 with 21 customers >10m.   

  • In August, introduced Cloud Paks, combining IBM middleware, AI, management and security, and RHT’s OpenShift platform to simplify cloud deployment.

  • Largest hybrid-cloud opportunity is in services, advising clients on architecture, moving workloads, building new applications, and management. 

  • Cloud & Cognitive Software +8.7% to 7.2bn

  • Global Business Services -0.6% to 4.2bn

  • Global Technology Services -4.8% to 6.9bn

  • Systems +16% to 3bn, IBM Z +62% due to recent z15 launch

  • Global Financing -25.3% to 301m reflecting wind-down of OEM commercial financing

  • Debt reduced by 3bn in 4Q, 10bn since RHT acquisition.

  • FY20 Guidance: adj EPS >13.35 (est 13.29)

3Q19   2.68 vs 3.42, -22%, est 2.67

  • Oct 16, 2019, P=142.11, TTM EPS=12.96, P/E=11X

  • Revs-3.9% to 18bn, -0.6% ex divestitures and f/x, GM 47.4% vs 47.4%, EBT Margin 13.3% vs 19.4%, EBT -33% to 2.4bn

  • RHT normalized Revs +19% to 987m but only included 371m in reported revenues due to purchase accounting, had strong RHT bookings, Cloud +14% organic to 5bn

  • Cloud & Cognitive Software +6.4% to 5.3bn

  • Global Business Services +1% to 4.1bn

  • Global Technology Services -5.6% to 6.7bn, below mgmt. expectations due to “lower in-period revenue from client business volumes in certain markets” predominantly UK and Germany  (~90% of GTS revs driven from backlog), signings +20%, driven by cloud which were +60% (cloud now >40% of GTS outsourcing backlog vs 25% at end of FY17).

  • Systems -14.7% to 1.5bn reflecting end of IBMZ14 cycle, INM Z15 started last week of Sept.

  • Global Financing -11.7% to 343m

  • Reduced debt by 6.7bn since end of 2Q

  • Signings +15% to 9bn, Backlog -5% y/y to 107.6b

  • FY19 Guidance: adjusted EPS at least 12.80, same as from investor day. 

  • Results reflect dilution from RHT as expected.  

  • Stock responding negatively due to revenue miss from GTS however seems transitory, solid signings in GTS and RHT continue to support thesis that transition continues. 

Aug 2, 2019 Investor Update with Red Hat

  • Grow Red Hat with IBM’s largest clients, expand in ~30 countries where Red Hat has little or no presence, scale Red Hat everywhere else

  • Expect >200bps of rev growth over 5 years (per annum?), accretive to GM in Year 1, accretive to EPS by end of Year 2 (primarily due to deferred revenue adjustment, Red Hat’s Deferred Revenue at closing was $2.8bn, will be ~0.6bn after closing adjustment).  

  • FY19 Guidance: IBM ~$14.00, Red Hat fundamentally contributes ~0.40 but offset by interest expense, deferred revenue adjustment, equity and retention, puts them at least $12.80

2Q19   3.17 vs 3.08, +3%, est 3.07 down from 3.26

  • July 17, 2019, P=143.07, TTM EPS 13.70, P/E=10X, FY20 P/E=10X

  • Revs -4.2% to 19.2bn (-1.6% ex fx), adj GM 57.4% vs 46.4%, OM 16.6% vs 16.9%, EBT -6% due to declines in now divested business (negative EPS impact of $0.15), ex these impacts EBT experienced positive leverage, 1-time gains offset charges, 

  • Cloud Revs TTM +5% to 19.5bn (+8% ex fx)

  • Cloud and Cognitive Software +3.2% (+5.4% ex fx)

  • Global Business Services +0.5% (+3.4% ex fx)

  • Global Technology Services -6.7% to 6.8bn (-3.5% ex fx), GM improved 120bps as they continue to de-emphasize lower value contracts. 

  • Systems -29.5% to 1.8bn (-18% rx fx), power +3%, more than offset by cycle in IBM  -41% vs +112% last year, Storage -21% 

  • Global Financing -11% to 351m (-8.5% ex fx) reflecting winding down of OEM commercial financing.

  • CFO 2.9bn vs 2.3bn, 2.8bn ex GF receivables vs 2.88, FCF 2.4bn vs 1.9bn

  • FY19 Guidance: On track for previous guidance excluding Red Hat, will update with impact of Red Hat on August 2nd.  Continue to expect accretive to FCF in 1styear and accretive to adj EPS by the end of 2ndyear, non-cash purchase accounting adjustments will be dilutive in FY19.  

  • Decent results especially factoring remaining business ex divestments, Red Hat will be dilutive but underlying IBM business continues to improve.  

1Q19   2.25 vs 2.45, -8% w 10% TR vs -30%, est 2.22

  • April 16, 2019, P=145.14, TTM EPS 13.61, P/E=11X, FY19 P/E=10X

  • Revs -4.7% to 18.2bn (-0.9% ex fx, est -3%), GM 44.7% vs 43.7%, EBT +28% to 2.2bn, EBT margin 12.3% vs 9.1%,

  • Cloud Revs TTM +10% to 19.5bn, +12% ex fx, Cloud as a service exit run rate 11.7bn, +10% or +15% ex fx

  • Cloud and Cognitive Software -2% to 5bn, +2% ex fx, 

  • Global Business Services flat at 4.1bn, +4% ex fx, GM improved 280bps

  • Global Technology Services -7% to 6.9bn, -3% ex fx, GM improved 110bps

  • Systems -11% to 1.3bn due to IBM Z product cycle and weakness in Storage

  • Global Financing flat at 406m, +4% ex fx

  • IBM Z was -38% vs +54% last year, now 7 quarters in and still tracking ahead of previous program (this was 2ndquarter of y/y decline), storage hardware -11%

  • FY19 Guidance: EPS and FCF guidance unchanged, expect 2Q EPS ~22% of FY19 EPS so ~3.06 vs est 3.26, 2H growth skewed to 4Q, higher tax rate in FY19 and weakness in IBM Z and storage overshadow underlying solid drivers, continuing to exit low margin business 

4Q18   4.87 vs 5.14, -5%, est 4.84 down from 4.90, FY18 13.81 vs 13.66

  • Jan 22, 2019, P=122.52, div=6.28, yield=5.1%, TTM EPS 13.81, P/E=9X, FY19 P/E= 9X

  • Revs -3% to 21.8bn (-1% ex fx), GM 49.5% vs 49.4%, EBT 23.1% vs 22.6%, EBT -1% to 5bn but EPS -5% due to tax rate 12% vs 6%

  • Cognitive Solutions flat @ 5.5bn (+2% ex fx)

  • Global Business Services +4% to 4.3bn (+6% ex fx)

  • Tech Services & Cloud -3% to 8.9bn (flat ex fx) with growth in hybrid cloud, 16 deals >$100m

  • Systems -21% to 2.6bn as last year IBM Z was strong

  • Global Financing -11% to 402m

  • CFO 4.1bn vs 5.7bn, CFO ex GF Receivables 7.3bn vs 7.8bn, FCF 6.5bn vs 6.8bn

  • FY Revs +1% to 79.6bn, flat ex fx, Strategic Imperatives +9% to 39.8bn (50% of revs), Cloud +12% to 19.2bn, (Services 11.3bn, Hardware 7.8bn), Service cloud exit run rate+18% to 12.2bn, OpInc -1% to 12.7bn

  • FY19 Guidance: adj EPS at least 13.90 (up slightly), FCF ~12bn vs 11.9bn in FY18, not including Red Hat due to uncertain timing but includes pre-closing financing costs, operating leverage and tax headwind, Divestitures will be ~1% revenue headwind

  • “Great singings quarter” in Global Tech Services “reflecting strong demand for hybrid cloud”

  • Data analytics, AI, and cloud continue to be important themes, clients increasingly focused on productivity

  • Client response to Red Hat acquisition has been “overwhelmingly positive”, mgmt. cited strong bookings Red Hat reported (they’ve had a partnership with Red Hat for a decade)

  • Continuing to reposition business for growth on top of its “annuity” business (they say 60% of revs) with opex rationalization to drive operating leverage. 

3Q18   3.42 vs 3.26 +4.9%

  • Oct 16, 2018, TTM EPS 14.21, P/E=10X

  • Revs -2% to 18.8bn, flat ex fx, GM 47.4% vs 47.5%, adj EBT margin 19.2% vs 18.7%, +1%, EPS +5%

  • TTM Strategic Imperatives +13% to 39.5bn (roughly 50% of revs), 3Q17 has strong software performance and was difficult comp, TTM Cloud +20% to 19bn (43% hardware, 57% service)

  • Cognitive Solutions -6% to 4.1bn with growth in Watson health, security solutions, 

  • Global Business Services +1% to 4.1bn (+3% ex fx)

  • Technology Services and Cloud -2% to 8.3bn, flat ex fx

  • Systems +1% to 1.7bn

  • Global Financing -9% to 388m

  • Def Revs 14.2m

  • FY18 Guidance: Continue to expect adj EPS >13,80

2Q18   3.08 vs 2.94, est 3.03

  • Revs +4% to 20bn, +2% ex fx, EBT +11%, EPS +5% due to tax headwind

  • TTM Strategic Imperatives Revs +15% to 39bn

  • Growth in all 4 major segments, best constant currency growth in 7 years, services ~60% of total revs on annual basis, 

  • FY18 Guidance: Continue to expect adj EPS of at least $13.80 vs 13.80 in FY17

1Q18   2.45 vs 2.35

  • Revs +5% to 19.1bn, flax ex fx

  • TTM Strategic Imperatives revs +12% to 37.7bn

4Q17   5.18 vs 5.01, FY17 13.80 vs 13.59

  • Revs +4% to 22.5bn, +1% ex fx

  • TTM Strategic Imperatives Revs +11% to 36.5bn