Since IBM sold off its PC business, moving away from the "commoditised" consumer computing sector into the more high end consulting and analytics business to serve the enterprise customer, its growth rate is nothing short of startling.
IBM might not be as hot as Google or Apple, but with a CAGR since 2006 greater than 17% and pre-tax income margins at 19.7% in 2010, IBM's modest PER of 14.6x might seem like a bargain.
Here's what they have been up to recently:
After Deep Blue vs Kasparov, IBM's engineers have been looking for the next challenge and found it in this supercomputing powering natural language processing Jeopardy showdown. But it isn't all fun and games at work. They believe that this technology can help businesses work better and they want to create a "smarter planet". They also have an ambitious plan to execute with their 5 year roadmap (to 2015). With a track record to boot, is IBM a growth company priced like a mature one?
Disclosure: At the time of post, I did not have open positions in IBM. Since then, I now have direct holdings in IBM.
Disclosure: At the time of post, I did not have open positions in IBM. Since then, I now have direct holdings in IBM.
IBM (NYSE: IBM)
22Apr11
P=168.28
This will be the first growth company I would be examining. Its products are what seems to me to be highly intangible, things like business analytics which is a growth area but hard to understand. IBM is a mega company, which would seem like a huge ship to steer, but its transformation, marked by the sale of the PC business (which it practically invented) in 2005 to China, has driven its share price to all time highs, for a company that has been around for 100 years.
Since it sold the PC business, its offerings are now completely enterprise driven. IBM’s position while not unique, for example, they are only one of several cloud providers, one of several mainframe providers, they do provide a unique value proposition in the sense of their integrated and adjacent offerings to businesses, and these adjacencies can provide a lot of cross-selling of related services and products.
In my analysis, as much as possible, I would try to analyse it without “paying for growth”. Meaning, let’s just look at it without making any assumptions that it is going to continue its trajectory of growth, despite evidence that it is well positioned to do so from its 10 year data, which shows all profit performance metrics practically in a straight line upwards.
EPS_10=11.52
PER_10=14.6x
EPS_ttm=11.52-1.97+2.31=11.86
PER_ttm=14.2x
EPS_11f=12.73 (source: 1q presser. This is a 10.5% increase from 2010, high but IBM recent CAGR is actually more than that.)
PER_11f=13.2x
EPS_2015f=20 (IBM’s 2015 5 year roadmap has that for the operating profit target, which is non-GAAP. Or 11.7% CAGR yearly).
PER_15f=8.4x
The FCF based on 2010 data gives FV=216.55 or a 29% margin (or 17x EPS_11f). This is attributable to IBM’s high use of cheap debt, where their total debt to cap = 56%. Its debt is rated AA3. IBM also has a strong trend of generating strong cash flows, which bodes well for them. Its growth is from organic investments, acquisitions and the divestment of commoditised products and services. FCF implies that IBM is currently priced for -1.5% growth.
Its ROE (calculated by EBIT/equity) is very high, 89% in 2010 (IBM’s AR reports ROE (using NI/equity)=66.9%), but its earnings yield is 8.42% which while respectable is on the not extremely high side. To bring it to 10%, RP=138 or it needs to fall by 22%. At FV, earnings yield would be 6.7% based on 2010 data.
Ultimately, the question is, do we buy the growth story here? IBM’s business is complex and its offerings are analytics and services alongside mainframes and software’s, mainly used by businesses and governments. While these are analytics is a high growth area, the sustainability of retaining consultancy services will likely be hit in the face of a downturn. Their outsourcing activities however would likely not be too badly affected, since outsourcing is a cost-reducing activity. Besides, much of such revenues are on a continuing and contracted basis, hence giving stability to the revenues. IBM says that for its biggest segment of Global Services, that the contributions of such revenues are 60-70%.
International revenues contribute >50% of their business, EMEA+Asia= 56% with Americas taking up the rest. I am unable to find a breakdown by their customer types in the 2010AR, even though it did state what are the industries that use them (e.g. financial, public service etc), and it states that no 1 customer forms more than 10% of its revenues in the last 3 years. While public services in USA might see a slowdown in the use of IBM’s services, other sectors would remain resilient, since the business cycle is going to now have an upturn. Less a major crisis, we are at the start of the mid-cycle, which means there is room to run yet for IBM’s growth.
In the last 10 years, it has gone through 3 PER regimes, the >20 phase from 2000-2005, the 12-16x phase from 2006-8 and since the 8-13x phase. It has now broken through 13, so it is in the 12-16x phase. So, IBM is by no means in cheap valuations territory from its historical valuations. What I do find odd is that a growth company (albeit in disguise) has such a low PER.
Another way of looking at it is that if it does hit its EPS of 20 in 2015, and at a 13x PER, TP_15=260. This is an 11% CAGR growth in share price. However, there is only the management guidance to bring the EPS to 20 in 4 years time, though it has had some track record for successfully executing its roadmap.
I think that as a growth company, IBM is underpriced. However, even without factoring any growth in the FCF computations, but implicitly assuming that FCF can be maintained, IBM is still undervalued. However, for it to reach the FV imputed at 216.55, this would only happen in mid-2013 at a 13xPER, even with a CAGR of 11% for its EPS, or at 15xPER, in 2012. This suggests that for IBM to reach its FV, 2 things need to happen. A PER expansion, and it needs to be able to sustain its growth rate which would drive the PER expansion. The thesis for IBM is that it is a growth company priced as a value company.
Conclusion: FV=216.55, or a 29% upside.
No comments:
Post a Comment