Why IBM Could Fall Further, With or Without a Dividend Hike

It seems like no matter who you ask, at least aside from Warren Buffett, shares of International Business Machines Corp. (NYSE: IBM) just cannot find any respect on Wall Street. For all practical purposes, the shares have been flat so far in 2015. And one analyst report from Thursday is not looking for any grand heroics from IBM any time soon.

Argus maintained its Hold rating on Thursday, but the firm sounded more like it was telling investors to sell rather than hold on. Argus said that IBM is accelerating its cloud strategy, but it is still running behind while it is de-emphasizing and downsizing its legacy enterprise IT hardware and solutions businesses.

24/7 Wall St. may have ignored this analyst rating on any other day, but we just named IBM as one of six big dividend hikes coming very soon. The dividend news is likely to be received well by investors. Still, IBM’s growth has been financially engineered rather than from organic growth inside its core businesses. Buffett may still be adding shares, and IBM may be one of Buffett’s top eight dividend stocks, but the rest of the investing universe seems to be scratching its head.

The long and short of the matter is that Argus sees the pace of IBM’s transformation as being not quick enough for impatient investors. Argus is now expecting activists to pressure IBM into divesting its low growth and low margin technology services divisions. Here is where Argus sounds like they want you to sell rather than hold IBM shares:

The decline in the IBM shares to levels last seen in mid-2011 may appear to represent an opportunity. But the market will likely regard IBM as a falling knife until investors can get a better sense of the company’s strategy going forward, along with its revenue and earnings prospects. … In 2014, IBM declined 15% while the peer group of eight Argus-covered information processing companies rose 16%. IBM shares declined 2% in 2013, while the peer group was rocketing ahead by 53%.

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Argus talked up Watson and cloud initiatives, but there are many things going wrong here. Core portfolio revenue declined 3%. Because of losses flowing through from the Globalfoundries transaction, and from share repurchases and other events, stockholder’s equity was reduced to $11.9 billion at the end of 2014 from $22.8 billion at year-end 2013. Thursday’s report further said:

Excluding debt from the global financing operation, the debt/cap ratio for non-GF debt jumped to 59% at the end of 2014 from 56% at the second quarter of 2014 — and from 39% at the end of 2013, and versus 36% at the end of 2012, and versus 32% at the end of 2011.

Further risks exist as well. Argus showed that IBM’s newest risk is that the slowing in demand visible in 2014 intensifies into 2015. Risks include competition in its hardware, software and services businesses, as well as legal issues and the possibility of further declines in IT spending.

At the end of the day, Argus did have some light positives to say about IBM as well. Argus noted:

These risks are mitigated by the company’s unimpeachable reputation and financial strength, which position it for net market share gains coming out of difficult economic periods.

Still, the main risks for further downside ruled over any upside comments. There was even hint that IBM could fall into the mid-$140s if more negative pressure remains:

Our comparable historical valuation model indicates value in the mid-$140s and remains in a declining trend. Our discounted free cash flow model renders a fair value in the $200s, also in a downtrend from peak levels above $300. In our experience, declines in calculated blended fair value are consistent with additional declines in the share price. We are unlikely to reinstate a Buy rating on IBM on a further price decline. To become more aggressive on IBM shares, we would need to see top-line progress, clear signs of stabilization in declining businesses, and offsetting growth in strategic imperatives. We also need confidence that management has created a clear path for guiding the significant legacy businesses to long-term growth and profitability. For now, a Hold rating appears appropriate.

IBM shares closed flat on Thursday at $159.81, and its 52-week range is $149.52 to $199.21. This may actually feel like a partial victory when you consider that the Dow closed down 117 and the S&P closed down 10 points. The consensus analyst price target is just under the current price at $158.45, but Credit Suisse still takes the “street low” target for the stock — all the way down at $125.

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