Why Jefferies Is Taking a Backseat on IBM

By Chris Lange Updated Jan 12, 10:13AM EST · Published Jul 12, 12:15PM EDT

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Why Jefferies Is Taking a Backseat on IBM — © Thinkstock

International Business Machines Corp. (NYSE: IBM) has struggled for year to get out of what some analysts have called a value trap. However, Big Blue hasn’t made the headway it needs so far in 2017. As a result, one analyst is slashing its target for the computer giant and sees further downside for the stock.

Jefferies reiterated an Underperform rating for IBM, and lowered its price target to $125 from $135. The prior closing price was $153.19, so the price target cut implies downside of 18%.

The brokerage firm’s checks suggest that while IBM offers one of the more mature cognitive computing platforms today, the hefty services component of many artificial intelligence (AI) deployments will be a hindrance to adoption. At the same time, Jefferies also believes that IBM appears outgunned in the war for AI talent and likely will see increasing competition. Finally, its analysis suggests that the returns on IBM’s investments are unlikely to be above the cost of capital.

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According to the Jefferies report:

Our checks suggest that IBM’s Watson platform remains one of the most complete cognitive platforms available in the marketplace today. However, many new engagements require significant consulting work to gather and curate data, making some organizations balk at engaging with IBM. As outlined below, many major companies are making significant investments in AI, and private capital formation is booming, growing over 50% to $4.25 billion in 2016 per CB insights, with nearly 1900 startups in the space tracked by Venture Scanner. Our analysis of job listings also suggests that IBM appears outgunned in the “war” for AI talent; Amazon, for example, has more than 10x the job listings of IBM. Finally, enterprises now have many choices for APIs from various providers; notably IBM dropped its pricing for Watson Conversations by 70% in October ’16.

In the firm’s base case, Big Blue barely recoups its cost of capital from AI investments, and Watson+associated “pull-through revenue” contributes 3% to consensus EPS in 2019. In the bull case, it’s still only 5%.

The firm also said:

We believe NVidia Corp. (NASDAQ: NVDA) is the biggest beneficiary of ramping AI adoption. We believe Pure Storage, Inc. (NYSE: PSTG), with its FlashBlade offering, is also likely to benefit in use cases above 10TB’s. We believe Mellanox Technologies, Ltd. (NASDAQ: MLNX) can also benefit from increasing demand on interconnect for AI applications but competitive concerns still keep us from being more constructive on Mellanox.

Shares of IBM were last seen trading at $153.59, with a consensus analyst price target of $164.36 and a 52-week range of $147.79 to $182.79.

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About the Author Chris Lange →

Chris Lange is a writer for 24/7 Wall St., based in Houston. He has covered financial markets over the past decade with an emphasis on healthcare, tech, and IPOs. During this time, he has published thousands of articles with insightful analysis across these complex fields. Currently, Lange's focus is on military and geopolitical topics.

Lange's work has been quoted or mentioned in Forbes, The New York Times, Business Insider, USA Today, MSN, Yahoo, The Verge, Vice, The Intelligencer, Quartz, Nasdaq, The Motley Fool, Fox Business, International Business Times, The Street, Seeking Alpha, Barron’s, Benzinga, and many other major publications.

A graduate of Southwestern University in Georgetown, Texas, Lange majored in business with a particular focus on investments. He has previous experience in the banking industry and startups.