The Bear Case for IBM Is More Compelling Than the Bull Case

International Business Machines (NYSE:IBM) has had a rough few years, and 2020 was no different. The lack of growth in revenues, earnings, and the stock price reflect its management’s defensive approach towards innovation. However, IBM stock still shows promise.

The company’s new CEO Arvind Krishna could usher in a new era. Krishna aims to make IBM a significant player in the rapidly growing AI and cloud-services sectors.

Though it has potential, IBM stock has a lot to prove before it can crawl out of its severe value trap.

Growth has stalled for IBM in the past few years. Its average EBITDA growth over the past five years is at a negative 6.8%. In the past four quarters, revenue growth has been negative. In fact, out of the past 10 quarters, its revenue growth has been negative in nine quarters.

Accordingly, IBM stock’s three-year returns are at a negative 20.6% compared to the S&P 500′s returns at 36.7% in the same period. Hence, a lot is at stake with the company’s foray into the AI and cloud businesses. With that being said, let’s look at the bull and bear case for IBM and see which one’s more compelling.

The Bull Case

Krishna has apparently breathed new life into the company’s operations.  He has a vision of seeing IBM as a front-runner in the hybrid cloud and AI businesses.  In doing so, he has engineered the acquisition of Red Hat and plans to invest in the company’s declining Managed Infrastructure Services division.

IBM is late to the party in the sectors mentioned above. However, Red Hat’s acquisition gives it access to the intellectual capital and hybrid cloud technology to catch-up quickly with its peers.  Red Hat’s Open Shift technology allows IBM to scale its hybrid cloud offerings and integrate them with other software.

Another attractive aspect of IBM is its dividend profile, which remains undeterred by the effects of the pandemic. It has raised its dividend payouts for 25 years and currently boasts a healthy yield of roughly 5%.

With a payout ratio of over 50%, its dividend is well-covered by its earnings. Moreover, the stock is highly undervalued across all significant price metrics. For instance, its forward price to sales ratio is more than 50% lower than the sector median.

The Bear Case

Now we come to uncomfortable truths regarding IBM, which appears to be more compelling than its bull case. Firstly, the company has failed to generate top-line growth for several years now. It will take time for the new CEO’s vision to come to fruition; hence near-term growth should remain repressed. Moreover, even if things go well in the next few years, it’s tough to say what level of growth it could potentially achieve.

With the spin-off of its Managed Infrastructure Services division, IBM will be divesting roughly $19 billion in revenue. This is likely to impact its dividend and total debt.

The company has quite a bit of debt, which is divided into core and global financing elements.  Its core net debt was at $26.1 billion coupled with its global financing debt worth over $21 billion. Though IBM has done well to generate free cash flows and subsequently pay off its debt, such a massive debt balance is a significant cause for concern.

Final Word on IBM Stock

IBM is a company in transition. The strategic shift was a long time coming, as the company has struggled to grow for years now. The new CEO’s aggressive push into the AI and cloud businesses are understandable, and could pay dividends down the road. It will be interesting to see how the company can grow its business in the coming future.

However, in the near-term, expect more of the same with IBM stock.

On the date of publication, Muslim Farooque did not have (either directly or indirectly) any positions in the securities mentioned in this article

Muslim Farooque is a keen investor and an optimist at heart. A life-long gamer and tech enthusiast, he has a particular affinity for analyzing technology stocks. Muslim holds a bachelor’s of science degree in applied accounting from Oxford Brookes University.