Shares of International Business Machines (NYSE:IBM) stock have been range-bound for years as revenues and earnings have continued to decline. In the face of that backdrop, IBM decided to go big by acquiring Red Hat for $34 billion.
This deal will be a defining moment for the current management team at IBM — and a defining moment for the future of the IBM stock price. Since the deal closed at the beginning of July, the third quarter will be the first quarterly report where Red Hat will be included.
IBM Stock’s Red Hat Acquisition
The Red Hat deal will push IBM into the cloud to help it compete better in one of the fastest growing segment of the market. The following chart I created compares the revenue for IBM and Red Hat over the last four fiscal years for each company.
Source: Data from Gurufocus. *Table data in millions, Red Hat-left axis, IBM-right axis
As you can see, IBM revenues have been trending down and they are stagnant at best. On the other hand, Red Hat has been growing revenues at a double-digit pace over the same period.
The big question that remains for this acquisition is this: Will Red Hat continue growing, or will the IBM management team fail to realize their acquisition’s upside potential.
What is astounding is to see the vast list of companies IBM has acquired since the current CEO has been in place and the revenue destruction that has taken place over that same period. Revenues in 2012 were over $102 billion, and for 2018, they were a little under $80 billion.
Given the history of acquisitions and revenue destruction, I have a difficult time believing in the current management team of IBM.
Share Repurchases
Share buybacks have helped IBM’s earnings per share to not fall much more than they did over the last five years. Since the beginning of 2015, IBM has lowered its share count by 9.35% at a total cost of just over $19 billion. According to the Q2 earnings call transcript, IBM is suspending share repurchases because of the Red Hat acquisition and focusing on deleveraging. This essentially shows IBM is going all-in on the Red Hat acquisition and only time will tell if it pays off.
Bottom Line for International Business Machines
The bottom line for International Business Machines stock is that they are in a “prove-it” stage right now. Their management needs to show that they can successfully integrate and continue growing Red Hat. With the suspension of the buyback, that means top line growth will be a very important metric for upcoming earnings. Given the history of revenue and earnings declines, the suspension of the buyback and integration of Red Hat, I believe a wait and see approach is best at this time.
As of this writing, Brad Kenagy did not hold a position in any of the aforementioned securities.
