As a sector, information technology has been one of the best performing around the past 12 months. That's the good news. The not-so-good news is that not everyone's enjoyed the ride, especially for shareholders of IBM (IBM 0.06%), Intel (INTC -2.40%) and LinkedIn (LNKD.DL). For various reasons, these three tech stocks haven't kept up with their brethren of late.
Then again, for investors in search of undervalued stocks in tech, the (relatively) weak performance of these three stocks offers an opportunity because they also share something in common: though they exist in disparate parts of the tech world, they're all in the midst of transitions.
Big Blue doing big things
Though up about 4% since announcing earnings on April 20, IBM remains one of the least expensive tech stocks around. As measured by price, IBM is trading at a mere 10 times future earnings.
The problem is that IBM's in the midst of a transformation away from its traditional hardware business to a provider of cutting-edge solutions including cloud, business intelligence (BI), big data and cognitive computing. Last quarter's 22.6% drop in hardware revenues, along with declines in most its other business units, has tempered investor's enthusiasm. But there's more to IBM's story than hardware.
CEO Ginni Rometty's aggressive cost-cutting initiatives are beginning to bear fruit, as evidenced by IBM's strong cash from operations and free cash flow (FCF) last quarter. But the real opportunity lies in what Rometty refers to as IBM's "strategic imperatives." As a group, cloud, big data, and BI revenues jumped 30% last quarter, led by IBM's cloud-related revenue pop of over 75%.
With an annual run-rate approaching $4 billion, IBM is quickly becoming a leader in the fast-growing cloud services market. When investors (finally) let go of IBM's legacy hardware results and focus on the new IBM, it won't be undervalued much longer.
Same story, different plot
Like IBM, Intel investors and industry pundits can't seem to get past its reliance on old-school markets: in this case, the PC industry. Seemingly every quarter, the headlines following Intel's earnings news reads, "Earnings hurt by decline in PCs," or some variance thereof. Which is exactly why Intel is an undervalued tech stock.
Intel CEO Brian Krzanich. Source: Intel.
Though investor's haven't gone all in as of yet, CEO Brian Krzanich has made it clear Intel isn't about PCs any longer. As the world moves to the cloud, the market for data centers is expected to explode, and Intel is already in the forefront of this burgeoning market. As Krzanich said last quarter, declines in PC-related revenue were offset by, "double-digit revenue growth in the data center, IoT, and memory businesses."
Not only did data center revenues jump nearly 20% year-over-year, the unit continues to make up a larger portion of Intel's overall revenues with each passing quarter. In other words, Intel is quickly becoming less reliant on the declining PC market and is driving growth via its cloud and Internet of Things (IoT) division -- which was up 11% last quarter. And also like IBM, Intel pays its shareholders a nearly 3% dividend yield, making it one of the best growth and income stocks in tech.
Enough already
Similar to IBM and Intel, LinkedIn is in the midst of a business transition. However, the professional networking king isn't steering its ship in an entirely new direction; it's in a hyper-growth mode via some recent acquisitions and a hiring binge. As a result, CEO Jeff Weiner and CFO Steve Sordello shocked many investors last quarter by drastically cutting its earnings forecast for 2015. And that's great news for tech investors looking for undervalued stocks.
Despite a 35% jump in revenues in Q1 compared to a year-ago, and a whopping 50% improvement in non-GAAP (excluding one-time items) earnings-per-share, LinkedIn's stock dropped like a rock following its earnings news, to the tune of about 25%. Earnings before interest, taxes, depreciation and amortization (EBITDA) was adjusted downward from $785 million to $630 million, and non-GAAP earnings-per-share expectations dropped from $2.95 to just $1.90.
The culprit is higher costs associated with assimilating new assets like LinkedIn's $1.5 billion deal for Lynda.com, continued hiring of new sales folks, and higher-than-expected costs to bring on new customers. For near-minded investors, the lowered projections were all they needed to hear. However, LinkedIn's growth strategies haven't changed; just the time frame in which it will accomplish them. And that translates to a golden opportunity for long-term investors.
