Dulat Atabek
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Revealing hidden value of IBM

Overview:

1) Nearly everyone hates IBM in Wall Street right now. This the chance for intelligent investor to buy cheap.

2) Wall Street doesn't give credit to "strategic imperatives" if the company. This is a mistake.

3) Financial Strength of the company

4) Cloud Wars

5) R&D have a bright future

International Business Machines Corporation (commonly referred to as IBM) is  multinational technology and consulting corporation, with headquarters in Armonk, New York.

We strongly believe, that IBM is very good investment for the 5 reasons:

1)

Nearly everyone hates IBM in Wall Street right now.

Revenue has declined in 14 consecutive quarters. IBM disappoints investors and misses analyst forecasts with each passing quarter. The stock price has lost a third of its value.

But it should be noted if you excluding foreign exchange and divestments, IBM's revenue was only down 1%.

2) Mistake of Wall-Street

IBM does business with the entire Fortune 2000. The company provides Services, Software and Hardware lines of business. The largest customers include American government, the Chinese government, Walmart, ExxonMobile etc.

In fact, 90% of the banks, 80% of the airlines in the world run on IBM and 60% of all the transactions in business are done by IBM. It is one of the most respected company in the world.

We believe that IBM's main asset is their customer list.

In 1990's IBM was on the verge of bankruptcy. In 1992 there was $8.10 billion loss because core business had been disrupted by a new personal computers era. In 1993 The company understand the primary needs of their clients. IBM made a big transition from manufacture computers to a model providing integrated solutions for clients.

These days we think this is s new big transition phase to a cloud computing-oriented company.

The company shows very impressive double-digit growth in what it calls its "strategic imperatives", which are new promising technologies such as big data, the cloud, cognitive technologies, internet of things. In 2009 the revenue of the strategic imperatives was only 13% of its total revenue. Last year this business doubled to become 27% in that time. Cloud computing business grew 65% in this last quarter versus the same period in 2014, $9.4 billion for the trailing four quarters. IBM spent approximately 6 percent of its revenue on research and development (R&D) and invested approximately $4 billion on CAPEX.

IBM sold Server x, the customer care outsourcing business, and its semiconductor manufacturing business last year because they had not been profitable. Also Lenovo acquired x86 server business.

They reinvested money from selling in the future technologies.

3) Financial Strength

IBM has good short-term financial strength.

Both current ratio and quick ratio are above 1 and continue to remain historically stable.

IBM has paid a dividend every quarter since 1916! The dividend growth rate is approximately 15% and is greater than its historical earnings growth rate.

IBM is a big free cash flow machine and we believe the dividend growth will continue above average.

We see the attractive and rare chance to invest in the very strong company at a P/E ratio 9.11 and a growing dividend yield of 3.79%.

Operating Margin ranked higher than 85% of companies in the Global Information Technology Services industry as well as Net Margins, which ranked higher than 87% of the companies.

As history has shown, among the same industry, a company with higher operating margin is more efficient in its operation. It is also more stable during industry slowdown or recessions. IBM survived the Great Depression, World War II, the Tech Bubble, and the Great Recession.

4) Cloud wars

Three companies share 54% of the market. These companies are Amazon, Microsoft, IBM. Every company have different focuses and the numbers are not directly comparable. While Amazon has core strength is its Infrastructure-as-a-Service (IaaS), Microsoft develops 3 directions: the Software-as-a-Service (SaaS), Infrastructure-as-a-Service (IaaS), and the Platform-as-a-Service (PaaS). But IBM focuses on "hybrid" cloud, which is where it lets customers mix-and-match their own data center infrastructure with its cloud services. However Microsoft (in particular) also work in that space.

We think IBM has "secret weapon": Watson, supercomputer based on cognitive computing. The company invest a lot of recourses in the supercomputer. And CFO of IBM, Martin Schroeter expressed his confidence that the aggressive investments made today will yield results in the future. The primary advantage of Watson that is completely open to all developers. This mean every developer can build smarter apps on top Watson and using the power of cognitive computing. These apps can be in any field. There have been already 3 companies from sport industries which will use to create intelligent apps. One of the biggest potential of using Watson is medical diagnostic. The supercomputer can diagnosis oncology better than human doctors in 97% cases. The competitor in this space is Microsoft with its Cortana Analytics Suite that takes a similar approach. However Microsoft hasn't let developer to integrate Cortana to their apps.

5) Research And Development.

A century of corporate life has taught IBM this truth: To make an enduring impact over the long term, you have to manage for the long term.

In 2014 IBM announced to spend $3 Billion on new semiconductor chips that no longer depended on silicon. Since 1965, chipmakers have operated under Gordon Moore's observation that they would be able to double the number of transistors in a one-inch diameter area of silicon roughly every two years. Modern chips with transistor gates are just 22 nanometers wide, with 14 nm chips coming soon. (Intel's announcement). IBM's spending much of its $3 billion to push for 7 nm silicon chips. In October 2015 IBM's scientists announced they made the 1.8 nanometer node! However IBM admits that the technology is still several years away. This technology can become very big profit in the future.

Valuation

As IBM is company with long history with high profitability Earnings model can be applied.

The Discounted Earnings model  calculated in the same way as Discounted Cash Flow model except earnings are used in the calculation instead of free cash flow. Growth rate is equal to the 14.5%, which is based on the growth rate of past 10 years.

Then value of the IBM is $288.67 per share with margin of safety equal to the 54.36%

Conclusion

IBM is a very financial strong company and we believe that every intelligent investor should consider to hold the shares. And the smartest intelligent investor in the world have already held them. Yes. Warren Buffet is the biggest shareholder of IBM.

Now we see an opportunity for intelligent investor to buy the stock at an undervalued price.