IBM Has a Growing Problem, but Are Investors Overestimating It?

IBM announces its seventh consecutive quarterly sales decline.

Jan 21, 2014 at 7:00PM

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

Stocks started a short week on a positive note, as the S&P 500 rose 0.3%. The narrower Dow Jones Industrial Average (DJINDICES:^DJI) fared less well, losing 0.3%, as earnings announcements from Johnson & Johnson and Verizon failed to impress investors. The Dow could experience the same phenomenon tomorrow, as the index's second largest weight, IBM (NYSE:IBM), is falling in the after-hours session; the company announced its fourth-quarter results after the market close.

Yes, IBM beat Wall Street expectations, with adjusted earnings per share of $6.13 versus a consensus estimate of $5.99, per the Thomson Financial Network. However, that beat was achieved on cost management and share buybacks, in spite of a 5% revenue decline. There's the rub for IBM.

If one wants to be charitable, one could remark that the revenue decline was just 3%, once you exclude the effect of currencies, but, somehow, I don't think that argument is going to carry much weight with the market, which wants to see IBM return to growth, or at least produce a credible strategy in pursuit of that goal. This is IBM's seventh consecutive quarterly revenue decline.

One element that is a source of hope: The company's leadership is well aware of the problem and is taking some responsibility for disappointing results. In a statement, CEO Ginni Rometty said: "In view of the company's overall full-year results, my senior team and I have recommended that we forgo our personal annual incentive payments for 2013." According to Reuters, Rometty's 2013 salary was $1.5 million, with an on-target annual incentive payment of $4 million.

The real "problem child" at IBM is the system and technology unit (which includes servers and storage), at which fourth-quarter revenues fell by more than a quarter relative to the year-ago period. IBM and a number of other tech behemoths, including Oracle and SAP, have been caught flat-footed by the shift toward cloud computing and "software-as-a-service." Only last Friday, IBM announced that it is committing $1.2 billion to "significantly expand its cloud footprint." As part of that effort, the company will open 15 new data centers this year to bring the total to 40.

IBM has a lot of work ahead of it, operationally and in terms of crafting a growth story that Wall Street will warm to. That will take time, so I'm not expecting any significant gains in the stock over the next six to 12 months. However, for investors with an equity-appropriate timeframe (which should be all investors) -- i.e., one that is measured in years, not months -- there may be an opportunity here: At 10.7 times the next 12 months' earnings per share, the shares appear to offer some margin of safety.

I'll just take the opportunity to remind investors that, at $188.43 (Tuesday's closing price), the stock price is only 10% above Berkshire Hathaway's cost basis -- i.e. the price Warren Buffett paid to make IBM Berkshire's third largest equity position.

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