Analyst Stays Lightly Cautious on IBM

International business Machines Corp. (NYSE: IBM) may screen like a cheap stock to many investors, but other investors and analysts consider it a value trap. On Friday came a brief note from Janney Capital Markets, maintaining its Neutral rating on IBM. The firm’s Joseph Foresi believes that IBM has to return to growth before it can get back to a “multiple expansion” expansion story. With it valued at nine times forward earnings, many investors have become more than impatient on that multiple expansion theory.

Foresi indicated that investors are getting closer to the bottom with each passing quarter. The bottom would be a positive turn in numbers, but he still sees IBM’s timing of reaching the bottom as uncertain — maybe early 2016.

Since IBM has put together a conference call series educating the investment community on some of its newer offerings, IBM focused on its “OpenPOWER” in the latest call.

The call from Janney Capital Markets talked about industry changes spurring IBM into OpenPOWER. Foresi said:

IBM is working to adapt to the new technology eco-system through OpenPOWER. The new eco system is one dominated by the Mega Data Center, who have chosen a different path to purchasing servers changing the traditional server refresh cycle. At its core, OpenPOWER increases IBM’s participation in the demand trends associated with hyperscale data centers, the domestic IT agendas, and high performance. OpenPOWER is monetized through third party and IBM implementation.

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Friday’s research note was about IBM reasserting its commitment to open source. With over 50,000 IBM employees using OpenPOWER to contribute to over 150 open organizations, the report shows that this was launched just in April of 2014 and that it was endorsed by the Chinese government via the China Power Technology Alliance. Another boost has been from the U.S. Department of Energy choosing the OpenPOWER design for a $325 million pact for a supercomputer. Another boost came from the British government investing over $175 million equivalent (at today’s exchange rate) in STFC for Watson and OpenPOWER.

On open source expectations, the Janney report said:

In the hyperscale data market, IBM is currently starting at 0% market share and any new sales will be IBM’s first piece of share taken, while IBM believes it currently has a single digit market share in high performance computing. Management targets a 10% to 20% share in each of these markets. OpenPOWER revenues are accounted for in the Power revenue segment and management stated they have already seen an inflection point in growth here.

All this sounds like incremental gains, but IBM is so large that it just does not move the needle yet. Along those lines, Janney Capital Markets is sticking with that Neutral rating and the $160 fair value estimate. For fiscal 2015, it sees non-GAAP earnings of $15.87 per share on revenue of $82.3 billion. The firm sees an operating margin of 22.7%.

Its fair value target is based on 10 times its fiscal 2016 earnings estimate.

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