Technology

Why Credit Suisse Sees a Big IBM Shortfall Versus the 2016 Bull-Bear Outlook

Jon C. Ogg

Published: January 14, 2016 10:20 am

Last Updated: January 13, 2020 3:03 pm

International Business Machines Corp. (NYSE: IBM) is one of the most disliked technology stocks and one of the most disliked Dow Jones Industrial Average stocks. Value investors think IBM is cheap, and Warren Buffett has kept piling in bad cash after bad cash to build his IBM stake higher. One problem is that IBM’s woes seem to persist, whether we have good times or bad times. Now Credit Suisse is out with a friendly reminder that investors need to be very cautious when it comes to Big Blue.

Credit Suisse’s Kulbinder Garcha has been and continues to be the most negative on IBM of all large brokerage firms. Garcha has an Underperform rating and a price target of $125.00. His view is that IBM remains a value trap and that the fourth-quarter earnings report next week will show that IBM is still in a multiyear painful turnaround.

IBM closed out 2015 at $137.62, and the consensus analyst target price at year’s end was $148.85. Just this week, 24/7 Wall St. ran a bullish and bearish outlook for IBM in 2016, and the consensus analyst targets generated an implied upside of almost 14%, if you include IBM’s 3.8% dividend yield. For the Dow to live up to a bullish case of 19,700 in 2016, it must mean a recovery in IBM.

Credit Suisse just doesn’t see that recovery. In fact, Garcha sees IBM reporting $21.9 billion in sales and $4.81 in earnings per share (EPS) for the fourth quarter. Those are against consensus estimates of $22.1 billion and $4.81 EPS. For 2016, Garcha sees IBM generating $79.4 billion in revenue and $14.03 EPS. The consensus estimates are $79.7 billion and $15.02 per share. For 2016, Garcha sees a 0.7% foreign exchange headwind for the revenues and additional headwinds from hedges rolling off.

Garcha sees 2016 as another year of contraction. His report said:

We see a painful multi-year turnaround from here, which leads to a prolonged period of underperformance. We reiterate our Underperform rating and price target of $125… For 2016, we fear another year of declining earnings per share… In addition, we expect standard free cash flow to come in at $10.9 billion in 2016, about $1.6 billion or 13% lower than 2015 free cash flow estimates of $12.6 billion.

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• Services — shrinking industry-wide deal sizes causing revenue headwinds and margin pressures.
• A shift to the cloud may ultimately be margin dilutive for IBM.
• Restructuring is becoming less effective.
• Weak employee morale.

Garcha did talk about the cloud business. While this has been an area of growth, it is not all with prize:

 The Cloud is getting more real. We do believe that large parts of IBM’s business (hardware, operating systems, Services) are being impacted by the Cloud, which represents more than 40% of the business. Our concern is the Public Cloud (represented by AWS with a $7.9 billion revenue run rate and a 46% CAGR LT) is very real and accelerating secular pressure.

What investors might consider here is that Credit Suisse has so far been more accurate than any Wall Street analyst. That can change on a dime of course, but the firm sticks with the notion that IBM is a value trap rather than a great value stock. While a headline price-to-earnings (P/E) ratio of nine does look inexpensive on the surface, Garcha notes that compared with similar large cap turnaround names he saw a trough valuation of 7.4 on a P/E basis. IBM was last seen valued at 12.3 times its enterprise value over free cash flow, versus trough valuations for peers at seven times enterprise value over free cash flow. Does this mean that if IBM hits the $125 mark that Garcha could lower his target price even further?

Does that mean that Garcha could get even more bearish on IBM? IBM shares were last seen trading up 0.6% at $131.93 on Thursday. The consensus analyst target price also has drifted lower to $147.75, versus $148.85 at the end of 2015. IBM’s 52-week trading range is $131.10 to $176.30.