International Business Machines (IBM) is a global diversified technology enterprise. The share price of the firm has declined recently as revenue has declined while management undertakes key growth initiatives.
I think revenue will increase in fiscal 2014 as the fiscal 2011 comparison was challenging. I'm looking for EPS of about $14.14 this year and $16.34 in fiscal 2014. The financial performance of the Software segment should remain strong with Global Services picking up in 2014 and the hardware segment stabilizing.
The average of the three valuation models suggests an intrinsic value of $258.20 per share, which is about 42% upside from the current share price. Right now IBM is trading about 15% off of its high price this year, which is the top end of my buy zone. Thus, this is a good time and price to accumulate shares of IBM.
IBM decomposes into five operating segments: Global Technology Services, Global Business Services, Software, Systems and Technology, and Global Financing. IBM's main operating segments by revenue are Global Technology Services and Software. Global Business Services is the third largest operating segment by revenue.
Global Technology Services primarily provides IT infrastructure and business process services; its capabilities include: strategic outsourcing services, global process services, integrated technology services and technology support services.
Global Business Services provides predictable business outcomes to the company's clients across two primary business areas: consulting, and application management services.
Software consists primarily of middleware and operating systems software. The key software categories are: WebSphere, Information Management, Tivoli, Lotus, Rational, and Operating Systems.
The Systems and Technology segment provides clients with business solutions requiring advanced computing power and storage capabilities. The major categories are: Systems, Storage, and Microelectronics.
Global Financing facilitates clients' acquisition of IBM systems, software and services.
To generate growth, IBM is focused on four key initiatives: Smarter Planet, Growth Markets, Business Analytics and Optimization, and Cloud Computing.
Smarter Planet is IBM's vision of a technology-enabled world that is more instrumented, interconnected and intelligent than ever before, enabling people and organizations to tackle significant business and societal challenges. Some of the smarter planet solutions are tailored to solve industry-specific challenges, which provides IBM with strategic advantages.
Business Analytics and Optimization ("BAO") is a category of software, systems and services that help organizations take advantage of all the data available to them for better and faster decision making and process optimization.
Cloud is a model for consuming and delivering business and IT services.
IBM is positioning itself well strategically: cloud computing, big data, growth markets and smarter planet are areas that should provide substantial revenue and growth in the coming decade.
The operating segments face different industry dynamics. The Global Services segments are growth segments, but they have faced headwinds recently; I expect those headwinds to continue in 2013 but to moderate by the end of fiscal 2014. The software industry is a growth industry; I expect Software revenue to continue to grow in fiscal 2013 and fiscal 2014. I think the Systems and Technology segment faces headwinds in fiscal 2013 and fiscal 2014 because of the longer product refresh cycle and the adverse impact of cloud computing on hardware demand.
The operating segments face different competitive environments. The Global Services segments are well positioned strategically, but face competition from Accenture (ACN) and Hewlett-Packard Company (HPQ). The Software segment provides some differentiated offerings, but faces stiff competition from Microsoft Corporation (MSFT) and Oracle Corporation (ORCL) in other areas. The Systems and Technology segment faces stiff competition from Cisco Systems, Inc. (CSCO), Dell, Inc. (DELL), EMC Corporation (EMC), HP and Oracle. Overall, I would say that Global Services is positioned the best strategically followed by the Software segment.
Consolidated revenue declined in fiscal 2012 and is on pace to decline in fiscal 2013. That said, the fiscal 2011 comparison was a challenging comparison. The combination of expense management and the shift to higher margin businesses has been driving the operating margin and net profit margin higher; that is a trend that I expect to continue.
I think fiscal 2013 revenue will be between $101 billion and $103.5 billion with an operating margin of about 19% and a net income margin of about 15.4%. In fiscal 2014, I'm looking for revenue in the $104 billion to $108 billion range with an operating margin of 20+% and a net income margin of 16.5+%. Consequently, I'm looking for EPS of at least $14.14 in fiscal 2013 and fiscal 2014 EPS of at least $16.34.
- IBM's Software segment could see a decline in revenue.
- The Global Services segments could fail to increase revenue in fiscal 2014.
- Weakness in hardware sales could be worse than currently expected and be a drag on consolidated performance.
- Competitors could beat IBM in the market.
- The share price is volatile and investors could lose a portion or all of their investment.
I'm going to use a few models to value the common equity shares of IBM. I'll use discounted cash flow models and multiplier models. At the end, the average of the valuation models is the intrinsic value. The current share price of IBM is $182.27; I estimate that the required rate of return for shares of IBM as 7.13%.
Assuming a 6% sustainable growth rate, I estimate that the intrinsic value of IBM shares is $327.43. If the dividend grows to $4.07 in fiscal 2014, the intrinsic value is $360.18. Thus, given the current share price, IBM is substantially undervalued using this model.
Using a payout ratio of 21%, I estimate the justified PE ratio as 18.58. Including my EPS forecast, the intrinsic value of IBM shares is $282.21. Using this model, IBM is substantially undervalued.
The multiplier model valuations will probably say that IBM is overvalued. The intrinsic value using the price/earnings ratio is $176.62, using the price/book ratio is $148.09, using the price/sales ratio is $164.04, using the price/cash flow ratio is $171.08. The average of those values is $164.96; this model is saying IBM is overvalued.
The average of the models and the intrinsic value of shares of IBM is $258.20, so IBM is undervalued by about 42%.