International Business Machines Corp. (IBM, Financial) has seen its share price on a downward trend since the highs of $205 in 2013. Following the pandemic crash in 2020, the stock enjoyed a market-wide bull run, rising 42%, but it has not yet reached pre-pandemic levels of $142 yet.
The legacy tech giant's share price has underperformed the S&P 500 over the prior month as well, despite beating Wall Street estimates for the fourth quarter of 2021. This may be due to potential corporate actions and cost pressures on their consulting business; many investors are thinking that even with short-term good news, the business is still in permanent decline.
Legendary investor Paul Tudor Jones (Trades, Portfolio) seems to be of a different mindset, though. He was buying shares of IBM in the fourth quarter of 2021, during which shares traded for an average price of $125 apiece. Moreover, in the past couple of quarters, there have been more gurus buying IBM than selling shares, as shown in the below chart:
Let's take a look at IBM's business model, financials and valuation to see what may have caught Jones' attention.
Business model
IBM was founded in 1911 and was truly a pioneer of the modern-day computing industry. Their unique culture of radical thinking, innovation and a strong sales force enabled this company to dominate the early computing industry. IBM’s mainframe computers had mass market share until they were disrupted by the home PC, Apple (AAPL, Financial) and disruptive software firms such as Microsoft (MSFT, Financial).
Today, after losing its dominance in the computer industry, IBM takes a “platform approach” to its business model. They offer a variety of consulting, IT Infrastructure and their flagship hybrid cloud platform Redhat. Redhat gives enterprises the flexibility to develop and change their IT infrastructure easily. For example, a large firm may wish to keep certain sensitive information on premises for security reasons and then use a public cloud provider (such as Amazon's (AMZN, Financial) AWS) for application development. Red Hat has over 3,800 customers using their platform, which include the British army, Palantir (PLTR, Financial) and many financial institutions.
Source: IBM investor materials
Redhat is expected to be the key driver of growth for IBM, as the global hybrid cloud market is forecasted to grow at a compound annual growth rate (CAGR) of 21.06% between 2022 and 2026, according to Mordor Intelligence.
IBM has over 40,000 active patents which generate income from royalties and offer a moat for the firm moving forward. However, the fact that IBM must rely on Redhat, a relatively recent acquisition, for growth should tell investors all they need to know about the status of the legacy businesses.
Financials
For fiscal year 2021, IBM’s revenue was $57.3 billion, down a massive 27% year-over-year. However, despite this, the gross profit was only down 11% to $31.4 billion, while the operating profit is at a very similar level to the prior year.
The new platform business model seems to be working well with fourth-quarter revenues coming in ahead of Wall Street's expectations. Their consulting business saw high growth with a 16% jump year-over-year to $4.7 billion, while earnings per share was up a massive 78% year-over-year to $3.35 in the fourth quarter of 2021.
Is the stock overvalued?
According to the GF Value chart, the stock is fairly valued at the time of writing.
IBM is a blue-chip IT giant which has strong roots in the industry. The company has downsized extensively over the past 20 years and is now finally adapting to the modern requirements of businesses. With the acquisition of Redhat in 2019, the firm has a strong offering for the hybrid cloud market, which is a growing industry.
I agree with the GF Value chart that IBM is fairly valued at its current share price. They do have room for huge growth; however, there is still a long way to go to divorce the company's image from its declining legacy businesses, and I believe there are better opportunities in the market right now.
