Entry Price: $141.5
Target Price: $164
Projected Yield: 15.9%
Time Line: 3 to 6 months
Position Size: 2.00%
Expected Dividend Yield: 4.70%
International Business Machines Corporation (IBM.US) offers comprehensive solutions and services for businesses around the world. Its products include cloud and cognitive software that partially mimics the human brain features, and are intended for healthcare, financial services, and the Internet of Things (IoT).
Earlier this week, Jim Whitehurst stepped down as president of IBM without explanation, after serving 15 months. This caused the stock to fall 5.50%. Previously, Whitehurst was a CEO at Red Hat, so his presence in the company was regarded essential to the success of IBM's hybrid cloud computing. Yet, this is overpriced by the market, as Jim Whitehurst will continue as an advisor to IBM's CEO Arvind Krishna and other executives. Beyond that, there are various other reasons for the recent drawdown in IBM stock being a great entry point.
What's the Idea?
The idea is capitalizing on a stock that may rise with the new business model, as well as with getting rid of inefficient divisions.
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Why Trade IBM?
Reason 1: Changes to Business Reorientation and Hybrid Cloud Technologies Development
Over the last few years, IBM tried to rebuild its business model in order to offer its customers a hybrid solution, which means not only a place in a public cloud storage (as Amazon Web Services and Microsoft Azure do), but also an on-premises private cloud. The focus, in the meantime, is on hybrid cloud computing. In order to achieve success in this domain, IBM acquired Red Hat in 2019 for $34B, which already had a huge amount of experience in this area.
The reasoning behind that is that IBM's large customer base will benefit from a mix of on-premises hardware and public cloud services rather than a single public cloud, which may not be a very secure option. Such a hybrid solution is especially attractive for customers looking for data privacy combined with saving on public clouds. This is true for the healthcare and financial service businesses and has already been implemented for Anthem and Pitney Bowes.
The cloud solutions market has enormous potential. Mordor Intelligence reports that the hybrid cloud computing market should be rising at an annual rate of over 18% through 2026. In addition, IBM's management believes the market is worth $1T, which creates a huge potential for the company.
IBM is unlikely to become a leader in this business and get a large market share, since the competition in the industryis already huge, and other companies, such as Hewlett Packard Enterprise, Microsoft (Azure), and Amazon (Amazon Web Services), have already managed to significantly advance in terms of cloud solutions. IBM does not need to conquer this entire business, however, as the market is too huge and even a small market share can have a serious impact on the company's financial success.
IBM's competitive edge is that both Red Hat Enterprise Linux and Red Hat OpenShift use popular code that can be industry standardized. This could allow public and private clouds to communicate seamlessly and securely. Besides, IBM is expanding its hybrid cloud product features through partnerships. Earlier this year, IBM partnered with Palantir Technologies to introduce the new Palantir product for IBM: Cloud Pak for Data that targets enterprise customers and enables access to AI applications through cloud with a minimum amount of code and an intuitive UI.
IBM also partnered with Verizon and Telefonica, offering them new services, from cloud based 5G to artificial intelligence. As a part of this collaboration, the company will supply the mobile providers with cloud services to manage their networks and help sell products tailored to customer needs.
Cloud solutions already started delivering significant results: over the last 12 months. IBM's earnings in cloud domain amounted to $26B (35% of total earnings) and grew by 18%. With further development and expansion, the company might well be able to recover its previous growth rates.
Reason 2: Business Restructuring to Increase Company's Flexibility
As stated above, IBM is aiming to change its profile from a company supplying computer hardware and software to a universal cloud service like Amazon's leading AWS or Microsoft's Azure. To this end, the company intends to restructure its business and allocate non-core assets.
By late 2021, IBM plans to spin off its Managed Infrastructure Services division into a separate publicly traded company called Kyndryl. It is yet unknown how large this company is going to be; however, we know that IBM's Global Technology Services, which houses Managed Infrastructure Services, brought $6.40B in earnings in Q1 2021 alone. Kyndryl is likely to become a leader in the domain, with a customer base of 4,600, including some of the Fortune 100 list.
It is also known that IBM wants to get rid of its medical division, Watson Health. The unofficial sources report that this business turned out to be unprofitable, despite solid earnings of $1B in 2020. Watson Health systems are powered by artificial intelligence, which is one of IBM's competitive edges. This unit was primarily aimed at medical technology and telemedicine.
The implementation of the restructuring plans will help the company become more flexible and use its resources to achieve the best growth opportunities.
Reason 3: Financial Performance
Currently, IBM company has some issues with earnings growth, mainly due to the downturn in the global technology service and system business domains. The earnings coming from cloud products rose by 18% in 2020, though. In Q1 2021, these earnings amounted to $6.50B, which is 21% higher than the same period last year, while the total earnings hit $17.70B, rising by only 0.90%. Q1's operating profit margin was at 5.10%, while the net profit one came at 5.40%, which is higher than the results of the previous year, excluding tax subsidy.
IBM is actively trying to improve its balance sheet: over the year, the company reduced its debt by $7.90B; the debt burden currently amounts to $56.30B. The amount of liquid funds is at $11.10B, while the Net Debt/EBITDA ratio is at 3.12x, which is just fine.
IBM is also generating a huge cash flow: over the last 12 months, the operating income amounted to $ 18.60B, and while the adjusted free cash flow hit $11.60B. Thus, IBM can reduce its debt burden without any issues, invest in new developments, and also pay huge dividends.
Currently, the core ratios show that IBM is somewhat underpriced compared to the competition: the EV/S is at 2.24x, the EV/EBITDA, at 9.79x, the current P/E, at 23.86, and the forward P/E, 11.60x.
IBM is special in terms of its dividend yield: currently, it is 4.70% per annum in USD.
In April 2021, various investment institutions and banks raised their target price outlook for IBM as follows:
- BMO Capital Markets: $150
- Morgan Stanley: $152
- Stifel Nicolaus: $151
- Credit Suisse Group: $165
How to Use the Idea
- Buy the stock at $141.5.
- Allocate no more than 2% of your portfolio for the transaction. To build a balanced portfolio, you can use the recommendations by our analysts.
- Sell the stock when the price reaches $164.
How to Buy IBM?
If you don't have an investment account yet, open it now: this can be done online, in just 10 minutes. All you need to do is fill out a short form and verify your account.
After opening an account, you can buy shares in either of the following ways:
Freedom24 Web Platform: In the Web Terminal section, type IBM.US (International Bus. Machines ticker in the NYSE) in the search box, and select International Bus. Machines in the results. Open a secure session in the trading window on the right, select the number of shares you want to buy, and click Buy.
Freedom24 iPhone or Android App: Go to the Price screen and tab the search icon in the top right corner. In the search dialog that will show up, type IBM.US (International Bus. Machines ticker in the NYSE) and select International Bus. Machines in the search results. You will then see the stock in the market watch; tap it and go to the Order tab in the dialog that shows up. Specify the number of shares you want to buy and click Buy.
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