IBM is standing at the crossroads

April 30, 2019 12:22
IBM has stayed in its comfort zone for too long. Photo: Reuters

Tech and internet stocks are surging, but there are exceptions. Old tech firm IBM, for instance, seems to be suffering from a legacy burden amid rapidly changing technology.

Buffett had bought IBM shares when they were really cheap, with a P/E multiple of barely 10 times. Back then, the company was touting about cloud and artificial intelligence like all other big internet firms.

Then IBM saw its core business continue to shrink.  Its cloud unit was growing at a much slower pace of around 10 percent a year, compared with rivals' 50 to 100 percent growth clip.

Its AI technology, known as Watson, is not based on the widely-used Monte Carlo Tree standard, which is why it is considered less desirable.

Buffett later sold his IBM shares following years of horizontal price movement.

In fact, it could have been worse. Despite lackluster results, IBM shares had been able to hold their ground, largely due to share buybacks and high dividend payouts.

IBM reported free cash flow of US$12 billion last year. Of this, it spent US$4.4 billion on share buybacks and paid US$5.6 billion dividends. It has bought back nearly 20 percent of its shares in last five years.

At the same time, IBM turned to the market to borrow money at low rates. Its net debt has hit US$35 billion by the end of last year, which is sizable for a company worth US$120 billion.

As the company's core business continued to shrink, management realized the share buyback game couldn't go on forever.

It has to find another solution. Last year, IBM decided to pay US$34 billion to acquire software firm Red Hat with a nearly 60 percent premium, in order to boost its cloud business. The deal marks IBM’s biggest acquisition in its history.

It was a heavy bet. IBM paid nearly three years of free cash flow to acquire the software company.

However, it's hard to say whether IBM's share price would continue to be resilient; it wouldn't be able to continue buying back its shares for a while after the huge acquisition.

All this leads us to ask: what’s wrong with IBM? Is the company falling behind technology-wise?

In my opinion, the problem is that the company has stayed in its comfort zone for too long. Members of its management team are mostly in their 50s and 60s, having worked in the company for decades.

Experience is not always an edge. It could turn into a legacy burden in a fast-changing tech world.

Anyway, IBM seems to understand its problem; it knows it has to do something to change.

This article appeared in the Hong Kong Economic Journal on April 26

Translation by Julie Zhu

[Chinese version 中文版]

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Columnist at the Hong Kong Economic Journal