INTERNATIONAL BUSINESS MACHINES CORP. $165(New York symbol IBM, Conservative Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 985.0 million; Market cap: $162.5 billion; Price-to-sales ratio: 1.8; Dividend yield: 2.7%; TSINetwork Rating: Above Average; www.ibm.com) traces its history back to 1911. Today, it’s one of the world’s largest computer companies, with operations in over 175 countries.
In the past few years, IBM has moved away from making computers to designing entire systems and managing them for businesses and government agencies. It provides these services under long-term contracts, which gives it predictable revenue streams. In 2014, computer services supplied 59% of the company’s revenue.
Meanwhile, IBM continues to build up its software business, which supplied 28% of its 2014 revenue.
Last year, the company sold its low-end server business to China’s Lenovo Group for $2.1 billion in cash and Lenovo shares.
It’s also selling its chipmaking operations to Globalfoundries Inc. It won’t get any payment; instead, it will pay Globalfoundries $1.5 billion to take over this money- losing business. IBM has also agreed to buy chips from Globalfoundries for the next 10 years. The company expects to close the deal by the end of 2015.
These sales have cut the contribution from IBM’s computer hardware division (mainframes and high-end servers) to just 11% of its revenue. Its financing division supplied the remaining 2%.
IBM’s revenue rose 7.1%, from $99.9 billion in 2010 to a record $106.9 billion in 2011. However, revenue fell to $104.5 billion in 2012 and to $92.8 billion in 2014. That’s largely due to asset sales. On a comparable basis, revenue declined 5.7% in 2014.
Earnings rose 11.9%, from $14.8 billion in 2010 to $16.6 billion in 2012. Per-share earnings rose at a faster rate of 24.7%, from $11.52 to $14.37, on fewer shares outstanding. Earnings then fell to $16.5 billion, or $14.94 a share, in 2013, and to $15.8 billion, or $15.59 a share, in 2014.
Analytics has huge potential
In the three months ended March 31, 2015, IBM earned $2.9 billion before unusual items, up 3.6% from $2.8 billion a year earlier.
The company spent $1.2 billion on share buybacks in the latest quarter, which is why per-share earnings gained 8.6%, to $2.91 from $2.68. Revenue fell 11.9%, to $19.6 billion from $22.2 billion. If you adjust for foreign exchange rates and the sale of the server business, revenue was flat.
A big part of IBM’s growth will come from analytics software, which can process huge amounts of data. That helps the company’s business clients boost their efficiency. In the past five years, IBM has spent $17 billion buying over 30 smaller analytics firms.
Perhaps the best-known part of IBM’s analytics business is its Watson supercomputer, which beat human contestants on the quiz show Jeopardy. The company now plans to invest $1 billion to create analytics programs that can take advantage of Watson’s computing power.
IBM also recently set up a business to develop software that analyzes data from smartphones, tablets, vehicles and appliances. The trend toward adding products beyond computers and mobile devices to the Web is called the “Internet of Things,”and it could total over 30 billion connections by 2020.
Proven brand brings a cloud edge
Meanwhile, IBM continues to build up its cloud computing operations. Unlike competing platforms, IBM Cloud offers a combination of secure local data storage and the convenience of cloud-based programs. In 2014, IBM Cloud formed alliances with German business software maker SAP and Chinese e-commerce firm Tencent.
In all, IBM plans to spend $4 billion on analytics and the cloud in 2015. It expects revenue from these businesses to rise to $40 billion by 2018 and account for 40% of its total, up from 27% in 2014.
Due to its recent asset sales, IBM’s research costs fell 5.3%, to $5.4 billion (or 5.9% of its revenue) in 2014 from $5.7 billion (or 5.8% of revenue) in 2013.
Even so, it won 7,534 U.S. patents in 2014, up 10.6% from 6,809 in 2013. This was also the 22nd consecutive year IBM received more patents than any other firm and the most ever awarded to one company in a single year. Licensing intellectual property generated $742 million in pre-tax income for IBM in 2014.
IBM’s strong balance sheet will support its transformation. Its $34.3 billion of long-term debt (as of March 31, 2015) is a moderate 21% of its market cap. It also holds cash of $8.8 billion, or $8.94 a share.
Manageable currency risk
The company recently updated its mainframes, which should boost its revenue and offset the negative impact of the high U.S. dollar; overseas markets supply 55% of IBM’s revenue.
IBM expects to earn $15.75 to $16.50 a share this year, and it trades at just 10.2 times the midpoint of that range. The $4.40 dividend yields 2.7%.
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