Reality Check: What If IBM Never Finds Its Way Back to Growth?

Jon C. Ogg

International Business Machines Corp. (NYSE: IBM) is now a company without a story. The growth initiatives under the leadership of Ginni Rometty have not been able to offset the bleeding in the core IT-services business that still dominates IBM. The company has spent billions of dollars buying back its own stock, but just recently the great Warren Buffett said “I surrender!” and sold some of his large stake in Big Blue.

24/7 Wall St. recently featured IBM as one of 11 great American companies that have lost their narrative. It almost no longer matters what management says or does, and the bears and short sellers have a louder voice at this time than any of the bulls.

IBM’s core business of IT-consulting and on-site consultants has a long-term chart that looks quite similar to a chart of smoking trends in America over the past two decades.

IBM also finds itself in a conundrum. Investors do not seem to want IBM to make a big acquisition, considering that it would likely have to overpay. The company’s strategic imperatives in the cloud, artificial intelligence, machine learning and so on just cannot grow fast enough. At issue is that IBM’s total revenues have been in decline for more than five years now, and no recovery is in sight.

Big Blue recently maintained its guidance for the full year at $13.80 in earnings per share. The consensus estimate at the time was $13.68 per share on $78.21 billion in revenue. Does 11 times earnings sound that expensive for one of the biggest technology stocks in the world? Is IBM a great value stock, or is it just a value trap with weakening internals?

After IBM’s second-quarter earnings report, many Wall Street analysts lowered their price targets. The worst two cuts came from Credit Suisse and Jefferies, with the former seeing IBM falling to $110 and the latter targeting $125 for the share price. If you average the worst two analyst calls, that would imply that IBM shares could have close to another 20% in downside.

Here is how some other analysts characterized IBM after its most recent earnings:

  • Barclays: Narrative Remains Tedious, as Strategic Imperatives Growth Eases
  • Guggenheim: Architectural Shift Is Not Growth, and Pressures Margins
  • KeyBanc Capital Markets: Not a Lot to Get Excited About
  • Wells Fargo: Revenue Stabilization Still Key; Not Quite There Yet
  • Oppenheimer: Still a Work in Progress
  • RBC Capital Markets: June-qtr EPS Ahead of Street Driven By Discrete Tax Benefit

It seems not so long ago (2014) that IBM had to jettison its long-term target of $20 in earnings per share. The problem for 2017 to 2019 is that analysts do not even see an earnings forecast of $15 per share, and IBM’s revenue is expected to just start forming a base rather than to grow again.

Strategic imperatives revenues grew by 8% in the second quarter of 2017, and this was led by cloud and mobile. In the Technology Services & Cloud Platforms, including infrastructure services, technical support services and integration software, revenue was down 5.1% to $8.4 billion (down 3.6% adjusting for currency). Strategic imperatives, driven by hybrid cloud services, grew 20%.

Rometty was recently featured by CNBC as having a salary increase of more than 60% to $33 million, one of the biggest salaries of America’s largest companies for a non-founding CEO. Does that seem like a deserved increase considering that revenue and earnings have declined this much and considering that IBM was a $210 stock in 2013? While it is easier to call for a CEO ouster than to exact it, the reality is that it’s hard to imagine IBM’s board of directors firing Rometty after granting such a large raise. At some point some of IBM’s top shareholders (including Warren Buffett, Vanguard, BlackRock and others) might start to put some serious heat on Rometty — and frankly it’s hard to argue against that heat not coming.

Shares of Big Blue closed at $154.10 ahead of earnings, in a 52-week range of $147.79 to $182.79. Its consensus analyst target price from Thomson Reuters ahead of earnings was $162.93. Fast forward just one week later and things look different, and for the worse: IBM shares were last seen closer to $147, the consensus analyst target price was down to $159.35. The 52-week low is now $145.80.

There is one last rather sad issue for IBM and the other companies that have lost control of their narratives. If they were to bring in a new CEO, would Wall Street even want to listen to them?