Recently Stan Druckenmiller discussed his IBM short in an interview with Stephanie Ruhle while at the Robin Hood Investors Conference on Thursday. He described how IBM (IBM) is one of the highest probability shorts he has seen in a long time, that Amazon AWS is "killing" IBM and you should buy IBM if you want to be short innovation. Of course, the 2,000lb gorilla in the room is who is on the opposite side of the investment, Warren Buffet and many other successful investors.
The media has taken Druckenmiller's call as a battle between two investors with very successful track records, but I see it differently. Buffett is cheering for IBM's share price to languish the next five years, so Druckenmiller's short call is a nice addition to the market's bearish view on IBM.
Remember from Berkshire's 2011 annual letter, Warren Buffett described the simple math of IBM repurchasing $50 billion over the next 5 years and the results in two scenarios. The first scenario used $200 as the average share price during the period, which would mean IBM would acquire 250 million shares. The second scenario used $300 as the average share price leaving IBM only purchasing 167 million shares. IBM originally had 1.16 billion shares outstanding which would leave 910 million outstanding in scenario 1 and 990 million shares outstanding in scenario two.
Buffett then said that in year five IBM could be earning $20 billion and scenario one would net Berkshire a $100 million greater share of those earnings than the "high-price" scenario.
Many will argue that small investors cannot think like Warren Buffett because he has a bigger share of the company and I have to disagree. It is all the same. We just own a smaller percentage of a company's earnings.
Let's say we own 1,000 shares of IBM instead of 63.9 million shares. Our position in IBM would be, get ready for it, 0.00000086% of the company. Say we bought shares today ($180,000 position) and use the similar scenario Buffett described above. In the first scenario, by year 5 we would own 0.0000011% of IBM. In the "high-price" scenario two, we would own 0.0000010% of IBM. That small 10 millionth of a percent would equal a difference of $2,000 ($22k in s. 1, $20k in s. 2) of earnings that should be going to you, if IBM earned $20 billion in year 5.
The 1.1% difference of our share of earnings to our original investment of $180,000 is the same proportion to Buffett's original investment, no matter how small a portion of IBM is owned.
The valid argument is that if IBM cannot sustain their competitive positioning, then cash flow will not sustain nor grow and shareholder's future owner earnings will deplete. My view is that IBM has a large moat with plenty of piranha, alligators and ferocious animals to continue to keep the owner earnings steady for many years to come. IBM continues to have sticky customer relationships all around the world, has the largest patent portfolio in the world and their business performance (not just revenues) over a long period has shown how great this company is.
The mistake that many large companies do with too much cash coming in is to make poor capital allocation decisions such as making ridiculously large business purchases, in turn destroying shareholder value. IBM has acquired 47 companies since 2009 but has not been seduced into making big headline purchases. IBM has spent on average only 17.3% of operating income on M&A purchases since 2009. Why? IBM management understands that 70-90% of mergers and acquisitions fail because of high prices and integration failures. What IBM has chosen to focus on is to send an average of 60.6% of operating income since 2009 back to shareholders via share repurchases. Don't forget the average 18% of operating income given back to shareholders as a dividend. I don't think shareholders should worry too much about IBM destroying value.
IBM, though not a high-flying innovator in the popular sense, is a company with predictable long-term cash flows making the company an equity with bond like qualities. Simply put, I don't think it is highly probable that IBM will be earning an EBIT of $15 billion in year 5 but if it did the earnings yield (EBIT/Mkt Cap) would be 7.6% at today's prices. That type of yield is still attractive when compared to the historical normalized 4-5% treasury yields and the 7-8% annual returns from the market. What I think is a more likely scenario is that IBM will be earning roughly $20 billion in operating EBIT once the world economy continues to gather steam and IBM further moves from hardware to software. In that case, IBM would yield an attractive 10.1% at today's price. Now if IBM continues to buy shares at low valuations, then our long-term returns should be enhanced.
Warren Buffett wants IBM's share price to languish and must be cheering Stan Druckenmiller's negativity on IBM. At current prices shareholders in IBM can directly and indirectly purchase shares at attractive valuations for the long-term. As a long-term shareholder of IBM, I wouldn't mind a few more short-sellers coming out of the wood shed trying to punish IBM's share price.
Additional disclosure: This article is meant for instructional purposes and not meant as a recommendation to buy or sell. The only kind of intelligent investing is through your own due diligence.