Is 2019 Going To End The Bad Spell For IBM?

It has been a tough year for tech stocks, owing to trade war fears, data privacy concerns, GDPR implementation in Europe and rising interest rates. International Business Machines Corp. (NYSE:IBM) , a renowned player in this space, is no exception to the trend. Year to date, the stock has lost almost 26.3%, compared with the industry’s decline of 20.6%.

Let’s take a look at the factors that impacted the company’s performance and see if there are any chances of revival ahead.

What’s Affecting IBM’s Performance?

IBM has been witnessed a year-over-year decline in its top-line in third-quarter 2018. Revenues of $18.76 billion declined 2.1% year over year. Cognitive Solutions’ revenues-external decreased 5.7% year over year to $4.15 billion. Revenues from Technology Services & Cloud Platforms-external decreased 2% from the year-ago quarter to $8.29 billion.

The inconsistent revenue growth, slow transition to cloud, increasing competition, and softness in cognitive solutions and technology & cloud platforms have been the primary reasons behind the company’s dismal showing.

IBM is under tremendous pressure owing to its time consuming business model transition, which is negatively impacting results. Despite significant investments, the company is yet to gain a strong foothold in the Infrastructure as a Service (IaaS), Platform as a Service (PaaS) and Hosted private cloud market. Intensifying competition in most of the markets is a major concern for the company.

Moreover, IBM’s continuing investments and pricing pressure related to its legacy hardware business is a concern. We believe the underperforming legacy business segments will remain an overhang on the company’s bottom-line till the business model transition, which is heavily time-consuming, is completed.

Additionally, ballooning debt levels have been troubling IBM over time. At the end of third-quarter, net debt amounted to $32.2 billion compared with $33.6 billion reported in the previous quarter.

Moreover, from a valuation perspective, the stock looks very unattractive as it currently trades significantly higher than the industry average based on a forward earnings estimate, which reflects a huge downward possibility. The company currently has a trailing 12-month Price/Earnings (P/E) ratio of 8.43. This is quite high compared with the current P/E for the industry that is pegged at 7.30.

IBM’s Efforts to Gain Ground

IBM’s growing presence in the enterprise artificial intelligence (“AI”) market on the back of an increasing clientele bodes well. Moreover, the company is benefiting from strong demand for z14 Mainframe and Power products. Its improving clout in the cloud, security and analytics remains a tailwind.

Additionally, blockchain has steadily gained prominence and is an integral part of IBM’s product offerings. IBM has also undertaken a number of blockchain initiatives to capitalize on growth opportunity in the industry.

IBM’s significant investments in “Strategic Imperatives” — cloud computing, mobile, analytics, cognitive technologies and security is adding to the positives.The traction witnessed by the company’s Watson offerings and IBM Cloud is anticipated to drive growth.

IBM has recently entered in a definitive agreement to divest seven software products to HCL Technologies for approximately $1.8 billion. The solutions are estimated to have a total addressable market (TAM) exceeding $50 billion. The move is in sync with IBM’s increasing focus on bolstering its hybrid cloud business. Further, IBM will gain $1.8 billion by divesting the software products. This is anticipated to improve the company’s cash position, which is crucial at this point of time.

Further, IBM recently entered into a definitive agreement to acquire Red Hat for approximately $34 billion in cash. With Red Hat’s synergies, IBM believes the company will be able to fast-track growth in the hybrid cloud space.

Will IBM Rebound in 2019?

Although the company is undertaking a number of initiatives to counter the aforementioned challenges, its impact on quarterly results has not been significant.

Moreover, all the efforts are at a very nascent stage and will take time to contribute meaningfully to top-line growth. This is a significant headwind in our view. Further, the stock, which was trading around $160 in January 2017, is now hovering around $113.This raises concerns among investors.

Consequently, it remains to be seen if the strategies can aid this Zacks Rank #3 (Hold) company to make a comeback in 2019.

Stocks to Consider

Some better-ranked stocks in the broader technology sector are Upland Software (NASDAQ:UPLD) , Marvell Technology Group Ltd. (NASDAQ:MRVL) and Twitter, Inc. (NYSE:TWTR) , all flaunting a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Long-term earnings growth rate for Upland Software, Marvell and Twitter is currently pegged at 20%, 9.4% and 22.1%, respectively.

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