Analysis Of IBM Including The SoftLayer Acquisition

Jun. 6.13 | About: International Business (IBM)

The share price of New York-based IBM (NYSE:IBM) increased in recent weeks following a sell-off that occurred because of disappointing first quarter earnings. Technology stocks have been laggards during the recent intermediate-term advance after outperforming the market for most of the bull market.

Shares of IBM are currently trading at an overvalued level. That said, the technology giant recently acquired SoftLayer Technology, which is expected to enhance IBM's software offerings. The software segment likely underperformed the industry in 2012.

With that, and more, taking into consideration, investors should reduce long positions in IBM. The firm is likely to continue underperforming the S&P 500. Also, IBM's solvency ratios continue to deteriorate, which is a sign of a recovering global economy. IBM's operations should be re-examined following an intermediate term share price decline.


IBM underperformed the S&P 500 for the last 52-weeks. The valuations will provide a piece of the, "Will IBM continue to underperform?" puzzle. In 2013, the street is expecting a slight decline in sales with solid earnings growth and outstanding earnings per share growth. As of right now, my forecast is roughly the same as the street's forecast, which suggests IBM should continue to underperform the S&P 500.

IBM [TTM] IBM 5-year Average S&P 500 [TTM]
Price/Earnings 14.0 12.5 16.9
Price/Book 11.8 9.2 2.4
Price/Sales 2.2 1.8 1.5
Price/Cash Flow 12.0 10.8 10.1
Dividend Yield 1.7 1.8 2.2
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Stocks that are undervalued have a tendency to outperform. IBM is overvalued relative to its recent trading history or on a time-series basis. IBM is overvalued relative to its 5-year average valuations. Also, IBM is overvalued relative to the S&P 500. Thus, IBM will probably underperform in the near term.

SoftLayer Acquisition: Upgrading Software

IBM acquired database Web hosting company SoftLayer Technologies and is creating a new division for clients interested in cloud services. The financial terms were not disclosed. SoftLayer provides its 25,000 customers, mainly small and medium-sized businesses, with cloud infrastructure. IBM is expecting the deal to close in the third quarter.

SoftLayer integrates and automates information technology elements, allowing customers to create cloud, dedicated or hybrid computing environments managed through a single interface. In addition, it offers VMware (NYSE:VMW) ESX, a bare-metal hypervisor that abstracts processor, memory, storage and networking resources to create multiple virtual machines. Enterprises of size can have control, security, scalability IT solutions. It also provides global, on-demand data center and hosting services from world-class data centers in Amsterdam, Dallas, Houston, San Jose, Seattle, Singapore and Washington, D.C.

In January of 2012, Global Innovation Partners valued SoftLayer at about $50 million, according to data from Thomson Reuters. Morgan Stanley and Credit Suisse Group are listed as the firm's financial advisors. SoftLayer is listed as private equity and venture capital backed.

This seems to be a smaller deal and should have minimal impact on IBM's future results. On April 22, 2013, IBM purchased UrbanCode Inc., which helps speed application delivery. In February, IBM acquired Star Analytics, which develops application automation and integration software. All three deals appear to be relatively small and aimed at improving IBM's software solutions.

Software sales increased 2 percent in 2012 relative to 2011 at $25 billion in revenue, Software is the second largest operating segment. These deals should marginally improve 2013 and 2014 results.

Less Solvent

There are several solvency and liquidity ratios. In this section is the current ratio, cash ratio, long-term debt-to-equity ratio, total debt ratio, and financial leverage ratio. Readers are reminded that IBM runs a customer finance division. Consequently, the leverage and debt ratio are higher than they otherwise would be.

The trend is toward IBM being less solvent. In this case, that is a positive sign. Because IBM runs a customer finance division, during an economic expansion, its solvency ratios will deteriorate.

Current ratio

Cash ratio Long-term debt-to-equity Total debt Financial leverage
Year-end 2010 1.19 0.29 0.95 1.24 4.90
Year-end 2011 1.21 0.28 1.14 1.56 5.75
Year-end 2012 1.13 0.26 1.28 1.76 6.28
Q1 2013 1.16 0.28 1.29 1.75 6.10
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The increase in the financial leverage ratio is a sign that IBM shares may be closer to a top than a bottom. Liquidity remains solid and debt levels aren't excessive. Investors should pay attention to the firm's financial leverage: I consider 8.5 to be the top of the safe zone.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.