Is It Time To Bet On An IBM Turnaround?
Investing.com | Mar 15, 2018 03:54
Investing in turnaround stocks is a high-risk but also a high-reward strategy. If you do your homework well you might end up with triple-digit returns.
Turnarounds can be described as the ultimate contrarian play since you’re betting on a company other investors don’t believe in. In most cases, turnaround situations may involve bankrupt companies that need to sell their profitable divisions, or companies that need to spin off unprofitable divisions, or aging businesses finding it tough to compete with new entrants and maintain their dominant position.
The century-old, tech-giant International Business Machines (NYSE:IBM) has been at such a crossroad for the past six years. Big Blue, as it's sometimes referred to colloquially, is struggling as technology and consumer preferences rapidly evolve, depriving this tech sector, legacy company of its main revenue sources. Chief Executive Officer Ginni Rometty’s efforts to refocus IBM’s business on the latest technologies—such as the cloud and artificial intelligence—have so far failed to impress investors.
During this transformation, IBM exited some markets, invested in cloud data centers and bought a number of companies to boost sales, bolster technology offerings and add troves of data to help train artificial intelligence (AI) algorithms. But those investments have yet to pay off.
During the past five years, IBM's share price has shed about a quarter of its value, at a time when, conversely, new technology companies such as Facebook (NASDAQ:FB), Apple (NASDAQ:AAPL), and Netflix (NASDAQ:NFLX) delivered triple-digit gains.
Should IBM’s faithful investors give up on what was once the country's most innovative tech firm and move on to other, greener opportunities? That depends.
IBM's most recent, quarterly earnings report offers a glimmer of hope. IBM returned to revenue growth in the fourth quarter of last year, putting an end to a five-year streak of declines, driven by the launch of a new mainframe system and double-digit growth in the company's "strategic imperative" businesses, which include cloud computing and security.
But a good performance in a quarter or two isn’t enough to prove a meaningful turnaround. Judging from the stock market reaction, investors aren’t impressed either. Warren Buffett, once one of IBM's biggest investors, has dumped almost all of his holdings in the company, according to the latest filing of his investment firm, Berkshire Hathaway (NYSE:BRKa).
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"I don't value IBM the same way that I did six years ago when I started buying," he told CNBC last year. "I think if you look back at what they were projecting and how they thought the business would develop, I would say what they've run into is some pretty tough competitors."
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Big Blue is still in the middle of its transformation and there's no guarantee its turnaround efforts will be successful. Last week, the company presented its longer-term vision to investors. The presentation was short on specifics but big on promises.
This was a deliberate attempt by management to avoid setting yearly targets, given the company’s bad experience with this short-term approach. Back in 2010, IBM set targets to achieve adjusted earnings per share of $20 by 2015. That proved to be too wishful a target. IBM wrapped up 2017 with an adjusted EPS of just $13.80.
This time around, IBM is envisioning low single-digit revenue growth, mid-single-digit pre-tax income growth, and high single-digit earnings-per-share growth. IBM plans to return about 70%-80% of free cash flow to shareholders each year, with annual dividend increases and continued share buybacks.
The company expects to reduce its share count by roughly 2% annually. IBM also plans to continue to build out its cloud and global services businesses, with "steady investment" in capital expenses as part of its longer-term model.
The bottom line: No one can tell for sure whether IBM management will be successful in turning the corner and putting this great company back on a growth path. One thing, however, is certain. It's going to be a long journey and only patient investors, with a 5-10 year time horizon, should consider buying this stock.
With shares trading at just 11.5 times adjusted earnings, a dividend yield of 3.8% and a very robust share buyback plan, betting on an IBM turnaround is risky, but could prove to be a solid, long-term investment—if you can afford to wait.
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