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Given International Business Machines's (NYSE: IBM ) poor year (losing 7% of its value), many believe it might now be a good value investment opportunity. However, this only applies if there is an unrecognized fundamental upside combined with a cheap stock. So, should IBM be on your radar?
What makes a good value investment?
A good value investment has nothing to do with stock performance, but is rather a combination of value in a company's stock and reasons to suggest future fundamental growth. With that said, IBM is undoubtedly cheap. The stock trades at just 12 times earnings and 1.9 times sales, but the question remains if the company has enough catalysts to trade higher, or if the company has bright growth prospects.
Hence, growth is always possible for a company as innovative as IBM, but two massive problems must be addressed.
Server defeat and share loss
IBM is a massive technology company that is not grounded to any one industry. In the company's last quarter, it produced total sales of $23.7 billion, which represented a 4% year-over-year decline. While the company had various strengths and weaknesses in the quarter, its system and technology, or hardware, sales were definitely disappointing.
Hardware is a large chunk of the IBM pie, accounting for 13.5% of total revenue in the last quarter, with sales of $3.2 billion. However, what's important to note is that sales declined a whopping 17% year-over-year. Many IBM investors blame hardware's weakness on the overall industry, as IDC estimates that server sales fell 6.2% in the second quarter and 3.7% in the third quarter.
However, it's not just the broader market that's weighing on IBM, but rather competition and the fact that IBM continues to lose market share. Most notably, Hewlett-Packard (NYSE: HPQ ) recently announced earnings, and reported a 2% year-over-year rise in its enterprise (hardware) business.
Clearly, if HP's enterprise is seeing year-over-year growth and IBM has declines, then HP is gaining market share. In fact, IDC estimates that HP is now the clear leader in this space with a 28.1% market share (up 150 basis points), while IBM has fallen to second with a 23.4% share (down 430 basis points).
IBM is not dependent on any one segment, but this rapid decline, coupled with HP's rise, is definitely noteworthy and something to monitor in the next year. This could also keep IBM from achieving growth.
IT feeling the pain
To explain IBM's business model, most would say it's an on-premise information technology company, as IT is IBM's main focus.
Recently, Barclays suggested that cloud migration is rapidly killing on-premise IT. The analyst, Ben Reitzes, believes that each dollar spent in the cloud takes multiple dollars from on-premise IT, as the main function of the cloud is to be more effective than traditional or existing business functions.
A couple of weeks ago, hedge fund manager Stanley Druckenmiller took this one step further, calling IBM a great shorting opportunity due to the "killing" nature of Amazon's (NASDAQ: AMZN ) Web Services, or AWS. Amazon is a market leader in cloud infrastructure, or laaS, and cloud app platform, or PaaS, growing at a rate of 55% year-over-year, and is expected to earn almost $4 billion in 2013.
AWS is quickly becoming a substantial piece of the Amazon equation, and this serves as an indication that on-premise IT companies like IBM could face continued revenue pressure. Moreover, the growth of AWS and the cloud industry might explain why sales of IBM have fallen from nearly $107 billion in 2011 to just $101 billion in the last 12 months.
Given the fact that the laaS and Paas businesses are expected to grow at a 45% rate, investors should be highly skeptical moving forward regarding whether IBM can produce growth in 2014.
Given the rise of laaS and PaaS, along with HP's rise in the enterprise hardware business, it's especially difficult to call IBM a value investment into next year. This value label becomes even more difficult considering the amount of revenue that IBM has lost in the last few years as a result of these challenges.
Moreover, IBM can't control the macro demand of hardware, but it can control its market share and the products that it offers. Combined, these reasons suggest that Druckenmiller is correct and that IBM is not a value investment, but perhaps a good shorting opportunity, or a stock to avoid at the very least.
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