Should I Buy IBM? 3 Pros, 3 Cons

by James Brumley | April 11, 2013 9:49 am

Saying that International Business Machines (NYSE:IBM[1]) has been confounding investors would be an understatement.

On the one hand, IBM fans are cheering the fact that UBS upgraded the stock from neutral to a buy. On the other hand, those same investors have to be wondering why this tech-service name is now the sixth-most shorted constituent of the Dow Jones Industrial Average; what are those naysayers seeing that the rest of the market isn’t?

There’s more to the company than just an unusually high level of investor pessimism contrasting with new-found optimism from analysts, though. So should you buy IBM? To decide, we’ll look at the pros and the cons:

Pros

Nine consecutive years of rising quarterly earnings: It’s a bit cliché, but IBM is one of the market’s few true earnings juggernauts. The company’s year-over-year income has grown for 37 consecutive quarters, qualifying it as one of the market’s most reliable company’s in the world.

Positioned to be a major player in cloud computing: There’s no denying that ‘cloud’ is quickly becoming the centerpiece of consumer technology, but it’s no longer a simple matter of just making the service available; the needs are becoming specific, and providers are finding their niche. IBM’s niche is the lucrative private (internal corporate) cloud infrastructure, which dovetails perfectly into its systems and IT infrastructure business. In other words, International Business Machines has an inside route to real revenue growth.

$10 billion in cash: Just to be clear, there are plenty of companies that have plenty more cash, but IBM’s $10.4 billion in the bank gives the $236 billion company a lot of opportunity to acquire businesses or technologies that it can leverage into growth machines. And if $10 billion isn’t enough, this monster-sized company has no problem borrowing more. That flexibility allows it to stave off most budding competition.

Cons

Entering the mobile arena: Getting into a new line of business usually means new revenue opportunities, so the fact IBM is acquiring its way into the fast-growing mobile-support game seems exciting. But this is totally new territory for IBM — it might not “do mobile” as well as its experienced competition can. Even more worrisome is how the focus will be on applications (where lots of competition already exists) rather than operating systems (the company’s bread and butter). Adding in the fact that the company plans to double its investment in mobile this year sets IBM up for some costly lessons.

Weak revenue growth: While earnings may be growing persistently, the top line isn’t. Last year’s top line of $104.5 billion was actually a tad lower than 2011’s sales of $106.9 billion. Granted, the company was still able to increase the bottom line by carefully managing expenses, but that’s not a viable long-term growth tactic. The top line’s only expected to grow 1.7% this year too, which doesn’t offer up a lot of opportunity for earnings growth.

Fading reputation in a key market: For years, IBM was the undisputed king of corporate computing, providing its client companies the ability to manage and use massive amounts of digital information. A recent study, however, indicated that Oracle (NASDAQ:ORCL[2]) now offers higher-performance solutions for companies needing a “Big Data” solution. It’s not had an impact on revenue, but it’s only a matter of time before prospective customers start to compare the two companies, and choose Oracle over IBM. (Note that IBM countered Oracle’s claims, pointing out the study’s comparisons weren’t apples-to-apples. Oracle was pitting one of its newer and costlier systems against an older and cheaper IBM system.)

Verdict

Clearly, some things are working in the company’s favor. It never hurts to have access to plenty of cash, and with mobile-mania in high gear right now, IBM’s entry into that race has won the market’s enthusiastic attention. But it’s not enough. IBM isn’t as equipped to play the mobile game as its competitors are, and lethargic revenue growth points to waning competitiveness in the company’s core business.

So should you buy IBM? No — you could do worse, but you also could do better … a lot better.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

Endnotes:
  1. IBM: http://studio-5.financialcontent.com/investplace/quote?Symbol=IBM
  2. ORCL: http://studio-5.financialcontent.com/investplace/quote?Symbol=ORCL

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