What Analysts Have to Say About IBM's Red Hat Acquisition Going Forward
International Business Machines Corp. (NYSE: IBM) announced last week that it is in the process of changing its software portfolio and what to expect from its newly acquired Red Hat. Analysts were quick to weigh in on IBM and they seemed fairly positive.
Nomura Instinet noted that IBM capped a full-throated avowal of its Red Hat deal by lifting its mid-term sales growth target from the low single to the mid-single digits, which exceeds this firm’s prior estimate. However, the firm also believes that a very high deferred revenue haircut will depress IBM’s EPS, if not cash flow, for two years.
Red Hat is expected to add 4% to 5% in 2020 and 2% to 3% in 2021 through organic growth and about 100 basis points from revenue synergies. IBM had previously anticipated low-single-digit growth. Rising gross margins should help operating income rise, though from a low base, as we shall see.
As a result, Nomura Instinet lower its 2019/2020 EPS from $13.90/$14.40 to $12.80/$13.55, in part on the deferred revenue purchase accounting adjustment. The firm estimates 2021 at $15.20.
Merrill Lynch pointed out that IBM expects pro-forma calendar 2019 EPS to be dilutive and at “at least $12.80” mainly due to deferred write-downs and interest expense, with EPS accretion returning in calendar 2021.
Free cash flow is expected to reach over a $13.5 billion level by calendar 2021. The brokerage firm sees IBM as well-positioned for the Hybrid Cloud and sees growth in free cash flow.
Merrill Lynch gave its investment rationale as:
We view IBM as a defensive investment given its high exposure to recurring sales, cost cutting levers, solid balance sheet, potential share gains, and relatively stable margins. We believe IBM will embark on further cost cutting, and enhance its services and software offerings through acquisitions. Longer term, we expect IBM to take share in IT spending with its Cloud and AI initiatives.
Separately, UBS reiterated a Buy rating and raised its price target to $170 from $160 for the stock. The analyst noted in the report:
For IBM’s stock to work the Red Hat acquisition only needs to deliver on cross selling; it doesn’t need to be the ‘game changer” that CEO Rometty envisions. That would be additional upside.
Shares of IBM were last seen down about 5% at $139.52, with a 52-week range of $105.94 to $154.36. The consensus analyst price target is $149.60.