IBM: Acquisitions, partnerships and dividends make me optimistic

International Business Machines (NYSE:IBM), also known as Big Blue, has once again made headlines. IBM is doing everything it can to focus on the future and get rid of any existence of its traditional business. IBM’s future lies in cloud services, artificial intelligence and consulting, which are what they focused on. IBM announced that it would work with Microsoft (MSFT) IN cyber security to help customers protect their hybrid cloud assets while modernizing their security offerings. IBM expands its watsonx portfolio, which will allow AWS users to benefit from a suite of products within IBM’s watsonx data and AI platform. It was also a busy year for IBM, as acquisition of HashiCorp for $6 billion to improve their hybrid cloud platform. Since IBM acquired RedHat, they’ve acquired companies like Octo and Apptio Inc. and made 4 acquisitions in 2024. Over the past year, IBM shares are up 32.64% to $177.30 after years of trading sideways below $140. Many investors have written off IBM and turned to companies like Amazon (AMZN) and the alphabet (GOOGLE) during a massive technology run, but IBM is back in the game. I have been bullish on IBM for years and I think the stock is going up because it is in a strong financial position and the shares look cheap term base.

In reference to my previous article about IBM

Even when IBM shares were trading below $120, I was still bullish. Since my last article on IBM (which you can read here ), the stock is up 20.28%, for a total return of 23.97%. This is slightly behind the market, as the S&P 500 is up 26.90% during that time, but given IBM’s sentiment, I think its turnaround is remarkable. I discussed why I think IBM’s transformation after divesting its legacy business was bullish. I’m continuing my previous article because IBM has had several strong quarters, has acquired more companies, and looks like a formidable competitor in the next generation of computers. From a long-term perspective, I’m very bullish on IBM’s future.

Risks of Investing in IBM

IBM has $53 billion in debt on its balance sheet, but its financials are strong enough that I am not concerned about future debt maturities. IBM generates over $14 billion in EBITDA per year and has the ability to meet its obligations. I believe the real risk lies in brand recognition and external competitors. IBM is one of the oldest technology companies and has been trying to shake off the stigma of being an outdated technology company for years. While IBM is doing everything it can to compete and provide value in cloud infrastructure and AI, there is a risk that enterprise and business customers will dismiss it as an outdated technology company and will instead engage with its competitors. IBM also faces competitive risks because it competes head-on with the largest companies in the world. IBM represents only 2% of the cloud infrastructure market, and its competitors are constantly innovating. IBM’s future lies in the cloud and AI, which could be a problem since it competes directly with companies like Amazon and Microsoft for customers. While I’m optimistic about IBM’s future, there are serious risks, and IBM may never shake the stigma of being an outdated tech company, no matter what it does.

IBM is in a strong financial position, and its fundamental outlook makes it seem undervalued

While IBM’s ability to innovate has been a subject of debate for years, its financial strength leaves bears with little to argue with. IBM ended the first quarter of 2024 with $14.60 billion in cash on its balance sheet. IBM has an additional $4.5 billion in marketable securities and $1.68 billion in other investments. IBM has over $20 billion in liquidity in cash and marketable securities, which can be liquidated fairly quickly since it’s in current assets. Like many companies, IBM has tens of billions in debt, with $54.03 billion in long-term debt. IBM has $6.31 billion in debt due in 2024, with an additional $10.53 billion due in 2025 and 2026. About $17 billion is due over the next 3 fiscal years, and IBM exceeds these liabilities between cash on hand and marketable securities. It is always important to look at the debt structure and see if the maturity is unmanageable. IBM’s debt is spread out over time and there is $30.53 billion left to repay after 2028, which works in their favor. While IBM generates over $14 billion in EBITDA and can manage its liabilities, we are heading into a lower interest rate environment and IBM may be in a position where it can refinance its long-term debt in 2025 or 2026 when interest rates come down significantly and increase its margin by reducing its interest costs.

Since spinning off a significant portion of its traditional infrastructure business in 2021 via Kyndryl, IBM has made no move to build its cloud-focused portfolio. IBM ended 2021 generating $57.35 billion in revenue and operating with a 54.9% gross profit margin. IBM generated 20.92% EBITDA profitability on its revenue, as 10.01% of its revenue fell to net income. Since then, IBM has grown its revenue by 8.23% ($4.72 billion) over the trailing twelve months (TTM), while adding over $3 billion in gross profit and $2.44 billion in net income. IBM has significantly improved its net margins, generating 23.27% EBITDA profitability on its revenue with a net profit margin of 13.18%. Some may think of IBM as a traditional technology company, but their move into cloud and AI is paying off as their margins and profitability are growing. IBM generated $8.18 billion in net income TTM. When we consider the level of liquidity on the balance sheet, IBM’s debt maturities become irrelevant as all of IBM’s debt obligations are met before net income is achieved.

Whenever someone makes an investment, they are paying the present value of all the future cash flow that the company will generate. When I compare IBM to the Magnificent Seven and then to older companies like Walmart (WMT), Home Depot (HD), and The Coca-Cola Company (KO), it looks interesting. The consensus forecast estimates may not paint the best picture for IBM, but given the trends in revenue and profitability, the bar is set very low. IBM is expected to generate $10.00 earnings per share in 2024, giving it a P/E ratio of 17.73. IBM is expected to grow its earnings by 11.50% over the next 2 years and earn $11.15 per share. That gives it a 15.90 P/E for 2026. I think this is an interesting valuation setup as investors can pay less than 16x 2026 earnings for IBM as EPS continues to grow and at this low level IBM can balance expectations and beat the top and bottom lines for many more quarters. I think IBM is in a position where it can shock the analyst community and if it does it wouldn’t be crazy to think the stock will catch on and rise to around 20-22x forward earnings.

IBM’s focus on the future benefits shareholders

In 2024, IBM acquired SKYARCH NETWORKS, Pilant, and HashiCorp, and also acquired application modernization capabilities from Advanced. The HashiCorp deal couldn’t have come at a better time, as it is a multi-cloud automation company. It focuses on enterprise clients and providing security and infrastructure lifecycle management. By integrating HashiCorp’s offerings, its clients can scale to automation in hybrid and multi-cloud environments. IBM continues to acquire companies to build out its cloud and AI portfolio. This will be an extension of IBM’s cloud environment and provide comprehensive offerings for IBM clients. In addition to software synergies, HashiCorp has over 4,400 clients, and some of the largest companies, including JPMorgan Chase (JPM) and Starbucks (SBUX), are using its products. This could open doors for IBM, and even if existing players don’t change their cloud environment, IBM may be able to offer them additional AI and cloud infrastructure products.

It all comes down to finances, and IBM is not adding to its debt by paying $6.4 billion in cash for HashiCorp. IBM will give HashiCorp a global sales force and will open its offerings in the 175 countries where it operates. Management expects the deal to be impactful to adjusted earnings before interest, tax, depreciation, and amortization (EBITDA) in the first full year of operations and to its free cash flow (FCF) in the second year. In a world where technology is evolving rapidly, IBM has just taken a piece off the table and expanded its solid portfolio. As IBM continues its M&A strategy, it is quietly building a powerhouse in cloud infrastructure and AI. At some point, it may not be crazy to think that IBM could become a target for acquisition by a larger company. I have said this in the past, and it would not surprise me if Alphabet acquired IBM in the next few years, as they continue to sit a distant third in the cloud race behind AWS and Azure. Even if that doesn’t happen, I think IBM is putting itself in a position where it can continue to grow revenue and profit, and it can do so without sacrificing its dividend.

During the Q1 earnings conference call, management clearly indicated that it is committed to its dividend policy despite recent acquisitions. This is good for income investors as the distribution growth should continue as IBM grows its revenues and earnings. IBM has grown its dividend for the past 24 years and currently pays an annual dividend of $6.68. This is one of the higher yields in the technology industry at 3.81%. IBM has grown its dividend by 1.92% over the past 5 years. As IBM continues to grow its EPS, I expect it to become a dividend aristocrat and begin to reward shareholders with greater annual increases. IBM can maintain and increase its dividend during this transition, which I believe is good for investors.

Application

I believe IBM is undervalued and overlooked as a true competitor in cloud infrastructure and AI. Despite spinning off most of its legacy infrastructure business, IBM is still seen as a legacy technology company. IBM has been executing on its M&A strategy since acquiring Red Hat, scaling into higher margins and more profitable businesses. I believe the bar is set too low and IBM is a bargain at less than 20x earnings. While we have seen a decent move up, I think IBM can string together a few strong quarters and change the narrative, which could drive the stock higher while investors receive a dividend that yields nearly 4% and continues to grow. I don’t see this streak ending, and while the stock has pulled back a bit, I wouldn’t be surprised if IBM crosses $200 by the end of 2024.