IBM ON TAP TODAY: WHAT CAN WE EXPECT?

ibm

IBM is on tap today on Wall Street. Its third quarter results are due after the markets close later this afternoon.  What can we expect?  More of the same (declines), or a trend reversal?

Screen Shot 2013-10-15 at 9.05.32 PM Screen Shot 2013-10-15 at 7.50.04 PM

The stock market has been basically flat in the last six months, the occasional up and down oscillations notwithstanding (left chart). IBM, on the other hand, also a part of the Dow Jones index,  has been decidedly down, both relative to the market and to its major competitors (right chart).  Even the lowly HP has done better despite the recent declines.

After cheering Big Blue for 15 months despite its declining results, Wall Street seems to have finally given up on it after its last earnings report in July (see IBM in Troubled Waters Again – historical analysis of IBM ebbs and flows; long term outlook and recommendations for change).  So is it too soon to write off Big Blue now, or not fast enough?

How about we let the facts try to answer that question? Perhaps it would be helpful to consider how IBM has been faring in the last three months relative to the Top 15 global IT leaders. So we took a closer look at all of them, both from the market and the business standpoints. And this is what we saw…

Top IT 10-15-13-1 Top IT 10-15-13-2

Furthermore, when we compared the current IBM stock price with that of its top competitors, we found out that one of the two things is true. Either IBM is undervalued, or the prices of the top echelon the IT industry are overinflated.  If one used the average P/E ratio of the Top 15, the IBM stock should be around $226.  Instead, it closed yesterday at $184.66. That’s a 22% discount relative to its peers.

IBM @ Top 15 P/E   

 22%

  $226  

  $14.09

 (EPS)

Based on what we see happening with stocks such as Facebook, we would tend to favor the latter explanation (that the Top 15 are overvalued).  And here’s why…

Take Facebook, for example. This newcomer to the Top 15 has seen its stock price double in the last three months. It was on pure hype. Its business results, i.e., the facts, had very little to do with it.  Check out, for example, how Facebook stacks up against Apple, the IT industry leader:

 

 

Market 

Revenue 

 Profit

FB/Apple

 

27%

4%

1%

At the $121 billion market cap, Facebook represents more than a quarter of the largest company in the world in this category. It’s bigger than Intel, SAP, EMC, Accenture, HP… But FB revenues are mere $6 billion (4% of Apple’s), and its net earnings $0.55 billion (1% of Apple’s).  So the FB valuation is a prime example of a stock rising on hot air. Once the balloon deflates, so will its market cap. When that happens, you don’t want to end up holding a lot of FB shares. Or for that matter the stocks of its competitors which similarly rose on hot air and wishful thinking.

Ditto re. the rest of the top IT leaders.  Their revenues are flat. The earnings are up only 2%. But the stock market keeps on boosting their prices (up 3% since July – see IT_Leaders10_15_13). Maybe that’s because they are so obliging to Wall Street bankers as to keep on selling themselves back to them? Stock buybacks are now as common on Wall Street as winter flu. As a result, the Top 15 IT equities are down 1.2% (since July!). Twenty years ago, nobody had even heard of such perversions as share repurchases. Now, the bankers have managed to persuade the leaders of the top corporations to manage their companies to extinction.

An exaggeration? Hardly. Take IBM, for example. At 102, Big Blue is the oldest company in the industry. One would think that, therefore, this company’s shareholders’ equity would be head and shoulders over that of other, younger companies’. Instead, IBM is only in the 10th position.   Even the lowly HP is bigger than IBM in this category (see above chart).

Which reminds us of what Wharton Business School Prof. John Persival said at an IBM conference in New York six years ago. He said that managing a company to extinction was “a viable low risk management strategy.”  He used Kodak as an example back then. Now that Kodak has bit the dust, his comments sound that much more prescient.

So back to our initial question – what to expect from IBM today? This writer’s money would be on further declines.  Alas, that’s only a figure of speech. For, I don’t own any of these stocks, including Big Blue’s. So if I am wrong after IBM releases its results today, you can only accuse me of stupidity, not of bias.

* * *

INITIAL WALL STREET REACTION SENDS IBM STOCK SHARPLY – DOWN!

IBM stock is down $5.83, or 3.3%, at $180.99, in after-hours trading

Well, this BARRON’S headline and the first story about the actual IBM third quarter release pretty much sums it all up. Looks like our expectation is coming true…

IBM Off 4%: Q3 Revenue Misses, EPS Beats; Maintains Full-Year EPS View

Looks like our expectations are coming tru​e.  IBM is continuing to shrink. And the stock market is finally starting to realize that there is no quick fix to its challenges.  The company is simply stuck in a place, like a giant with feet of clay, just as we said in April 2012, when we first identified this declining trend (see Big Blue Feet of Clay).
Big Blue in Small Pond
What’s worse, the company’s management seems to be living in a bubble of its own ​making, detached from reality. Even of its own numbers. Check out this oxymoronic statement from IBM’s third quarter release:
Growth Markets 
 
Revenues from the company’s growth markets were down 9 percent (down 5 percent, 
adjusting for currency). Revenues in the BRIC countries — Brazil, Russia, India and 
China — were down 15 percent (down 12 percent, adjusting for currency). 

This IBM business segment is down 9 percent, the biggest countries (BRIC) are down 15%, and the company management is still referring to them as “Growth Market”?! China, on the other hand, a part of the BRIC, was down 20%, according to Mark Loughridge, the IBM CFO. And most of it was due to a lack of demand for IBM hardware (China accounts for about 5% of IBM and 40% of that total is hardware, said Loughridge).

But Japan, the largest IBM Asian country, was down 17%. And so was Russia, along with Eastern Europe, which declined in double digits.

Undaunted, Loughridge predicted that IBM “growth markets” would return to “mid single digit revenue growth” – next year.

Hm… Here’s what Loughridge said in April 2012 about these so-called “Growth Markets”:

“Once again, our growth initiatives led the performance. Our growth markets initiative is based on expanding into new markets, building out IT infrastructures and leading in targeted industries.” And we all know what happened since April 2012, don’t we?Finally, the Total Signings in the company’s biggest business segment – services, by far the most significant Screen Shot 2013-10-16 at 2.12.37 PMindicator of future IBM revenues, was also down 7% in this quarter ($12.3 billion).

So is there any wonder the stock is down? As one of the analysts said in the post-earnings conference, IBM’s recent performance is “way out of whack” with its historical trends. He also pointed out that the only reason the IBM third quarter earnings APPEAR to be up was, what this writer calls, “financial engineering” factors (much lower tax rate, excluding some one-time charges, etc).

Over a longer period recently you’ve had six straight quarters were revenue growth has been negative. You’ve missed consensus revenue expectations for seven straight quarters.

“So my simple question is what’s changed in the last six or seven quarters?” this analyst asked. And “whether we should be thinking about a financial model that is more like 0% revenue growth and something less than double digit earnings growth on a sustained basis?”

The IBM CFO offered a long and convoluted diatribe which skirted around a direct answer to the analyst’s question. Loughridge’s beating around the bush could be taken as another sign of trouble in the Big Blue bubble.  For, the first step in solving a problem is one’s willingness to admit that there is a problem. Which is still clearly not the case at IBM HQ.

So SELL will probably be the operative word when the markets open tomorrow. And not just IBM. The rest of its Dow Jones cohorts are likely to be pulled down by the IBM wave rip tide.

“During the past 12 years, the move in IBM’s shares the day after earnings has accurately predicted the market’s direction over the ensuing five weeks 75% of the time,” according to Bespoke Investment Group. When IBM shares have fallen after earnings, the market has typically followed, and vice versa (see (see IBM Poised to Be Drag on DowThe Wall Street Journal, Wed 5:35PM EDT)).

“No other stock in the S&P 500 has been more consistent over the last 12 years in accurately predicting the performance of the S&P 500 over the following five weeks,” Bespoke co-founder Paul Hickey wrote to clients.

And now, IBM is developing another (unwelcome) type of consistency. Its revenues have been declining for six quarters in a row. That’s not helping the “S&P 500 Brotherhood” very much, is it?  Most of these corporate dinosaurs are reporting slow or no growth. Why? Because they are either unwilling or unable to change and adapt to the web-based New World.

Well. nothing new there. Check out this chart from 2006…

Screen Shot 2013-08-08 at 8.14.41 AM

Which is actually an updated version of a 1996 chart we showed the then IBM CEO Lou Gerstner when he told him he had hitched the IBM wagon to the wrong train (see Louis XIX of Armonk).  He did it anyway.  And IBM is still doing it.

​Bob

PS: By the way, while we were writing this update, the IBM stock was plummeting like a rock. As of right now, it is down over 11 points (down 6%)!

After Hours : 175.60 Down 11.13 (5.96%) 4:57PM EDT – Nasdaq Real Time Price

* * *

  TOP 10 IT GLOBAL LEADERS
Top 10 IT Cos. Mkt Cap Trail P/E Change   Mkt Cap Trail P/E
15-Oct-13 17-Jul-12
Apple $453.05 11.33 -20% $567.53 14.01
Microsoft $287.30 14.73 15% $249.17 9.19
IBM $202.28 13.98 -5% $211.84 14.93
Google $293.73 22.08 56% $188.02 20.90
Oracle $149.26 20.14 2% $146.08 18.01
Cisco $124.28 13.56 43% $86.94 16.04
Facebook $120.55 76% $68.54
Intel $116.53 9.98 -9% $127.69 10.79
SAP $86.25 24.36 19% $72.54 20.09
EMC $51.29 19.94 7% $48.13 23.05
Avg Top 10 IT $188.45 16.68 7% $176.65 16.33
Avg Top 15 16.01
IBM stock on 10-15-13 $184.66
IBM @ Top10 P/E  22% $225.58 $14.09  (EPS)
IBM stock on 7-17-12 $183.65
16-Oct-13    Source: Annex Research

* * *

Global IT Leaders – Business & Stock Performances
Market Stats
Industry Market Change  Value       P/E Change 
Segment Cap from Gained/       Ratio from
2013 ($Bill) Jul-13 (Lost) ttm Jul-13
15-Oct-13
1 Apple Consumer $453.05 13.2% $52.71 12.43 22.1%
2 Google Consumer $293.73 -4.1% -$12.49 25.52 -7.6%
3 Microsoft Software $287.30 -3.6% -$10.58 13.37 -27.4%
4 IBM Conglomerate $202.28 -5.0% -$10.69 13.11 -1.1%
5 Oracle Software $149.26 3.1% $4.55 14.07 1.7%
6 Cisco Hardware $124.28 -10.4% -$14.35 12.46 -13.5%
7 Facebook Consumer $120.55 92.4% $57.90 223.00  !!!
8 Intel Hardware $116.53 -1.9% -$2.28 12.64 5.9%
9 SAP Software $86.25 -3.8% -$3.38 22.53 -5.7%
10 EMC Hardware $51.29 -2.1% -$1.10 19.52 -3.4%
11 Accenture Services $45.99 -5.6% -$2.71 14.51 -14.2%
12 HP Conglomerate $43.80 -13.3% -$6.71 LOSS
13 Yahoo Consumer $34.06 15.5% $4.58 9.19 16.3%
14 Dell Hardware $24.32 4.0% $0.93 18.03 43.2%
15 Fujitsu Conglomerate $8.08 -5.0% -$0.42 LOSS
Totals/Averages $2,040.77 2.8% $55.96 31.57 97.2%
w/o FB 16.01 5.2%
16-Oct-13    Source: Annex Research ttm – trailing 12  months;  MC/E – market cap/equity

* * *

WHAT’S UP WITH HP? ACTUALLY, NOTHING. AND THAT’S THE TROUBLE…

Annex logo web

[click on images to enlarge]

Screen Shot 2013-08-21 at 6.16.28 PM 

All lines point south. Except stock price. To see real HP, one must turn Wall Street’s view upside down. 

HP Declining ibm

IBM & HP: Two Peas in a Pod

virginia-rometty-IBM Meg Whitman

It has been more than seven years when I wrote the story IBM vs. HP: A Tale of Two Blues (June 2006). If I were to do it today, its title would be “Two Peas in a Pod.” Both computer giants are shrinking. Both are stuck in place while desperately trying to create an impression of change. Neither is able to break the shackles of their corporate cultures. But only one has been favored this year by Wall Street. HP stock is up 78% in 2013 to-date.  God only knows why…

New-York-Stock-Exchange-building         HP logo upside down

Which is why it might be instructive to bring back that image we published a few weeks ago.  There is no room for reason at the Wall Street manger. What’s been happening with the HP stock this year is another proof.

* * *

THIRD QUARTER ON TARGET YET STOCK DROPS

HP’s third quarter results were “on target,” as far as Wall Street is concerned. Yet its stock dropped 8% in after-hours trading. Why? Because investors may be starting to realize that they have been falling for their own hype. Just as what happened with IBM last month.

Screen Shot 2013-08-21 at 6.38.09 PM

In HP’s case, the latest results marked the eighth consecutive quarter of year-to-year revenue and EPS declines. In other words, HP’s downward trend is even longer than IBM’s.

And no wonder. All major HP lines are shrinking. The PC unit was the worst performer in the latest quarter. Revenue dropped 11%. The printer unit fell 4%. Enterprise group and enterprise services each declined 9%.

HP CEO Meg Whitman said on today’s earnings call revenue growth is unlikely before the close of the fiscal year ending in October 2014. That sent the stock tumbling.

Well, at least the HP CEO is being a little more realistic than the other Big Blue CEO.  When IBM disappointed the market with its second quarter results last month, CEO Ginni Rometty continued to promise a turnaround.

“We expect continued improvement through the second half of the year,” she said in a release (see IBM in Troubled Waters Again).

Actually, neither company is doing anything radical enough to constitute real change. Both will need to basically reinvent themselves from ground up if they are really to move up. Neither seems willing or able to do it. Maybe they should spare their shareholders the agony of watching their favorite Big Blues shrink year after year.

We are reminded of a September 2007 luncheon conversation this writer had in New York with Professor John Persival of the Wharton  School of Business.38_UN_24

“Commoditization is driving the growth and (leading to) lower margins,” he said.

To I pointed out that growth and margins needn’t be mutually exclusive.  Creative companies can have both. I cited Apple and Google as examples. “They are experiencing both high growth and high margins,” I said.

The professor agreed.  “All these companies (industrial era relics) used to be Apples and Googles once,” he replied.  “But they lost that edge.  And now they have to choose between growth and margins.”

And then he dropped a bombshell. He said that managing a company to extinction was “a viable low risk management strategy.” (see Globalization Pandemic, Oct 31, 2007).Kodak

Prof. Persival then cited Kodak as a case in point. It was a prescient example. For this American legend founded in 1880 filed for Chapter 11 bankruptcy in Jan 2012. Creditors stand to get only  4¢ or 5¢ on the dollar for their investments and that they’re entitled to be paid before shareholders are. Generally, holders of common stock do not receive anything for their shares when a company emerges from bankruptcy.

See what I mean about saving the shareholders the agony?

By the way, perhaps you have noticed the juxtaposition of the HP logo to help see the real picture at that company today?

HP logo upside down HP logo

What do you suppose missing suffix of “dy” should be? Dy-ing or dye-ing? You decide. 🙂

Happy bargain hunting!