International Business Machines (NYSE:IBM) has suffered a lot over the past two years. The company has not been able to keep up with the changing trends in the sector; as a result, revenues have been falling for the company. To tackle this issue, the company devised a strategy to focus on more lucrative segments of the market and put a target of $20 in EPS by 2015 - its current EPS stands at $14.94, up from $11.67 in 2010, the year the company set the target of $20 in EPS. However, the firm is finding it hard to meet its goal given the falling revenues for seven consecutive quarters.
The trend in the stock price has been consistent with the earnings performance of the company, and it has lost more than 4% during the last year. However, I am optimistic about the long-term value of the stock. In my opinion, the strategic steps taken by the management will result in long-term sustained growth for the company.
Restructuring in the Underperforming Business Units
When a firm needs to increase its profits, either it has to increase its revenue or decrease its cost, or a combination of both. Similarly, IBM has recently announced its $1 billion restructuring plan to meet its target EPS. To start with, the company is trimming its workforce. The company has begun to let go of its employees in Europe, South America and Asia, as reported by Alliance IBM. Overall, job cuts of this year may come up to roughly 13,000 employees as estimated by an analyst at Sanford C. Bernstein & Co.
IBM is mainly cutting jobs in business units which are underperforming. It was reported that IBM is going to let go 25% of its employees in Systems and technology division, also known as hardware division. This is the group which is involved in making IBM servers which is under performing. For the profitable business units, the company has over 3,000 jobs available all times which includes its nanotechnology and Cloud business. This would allow the company to dedicate more focus and resources to the better performing business units and would lead to better asset utilization.
Along with the restructuring in the hardware segment, the company is focusing on expanding its cloud and software businesses. IBM's plans for 2014 are to invest $1 billion in its Watson business and $1.2 billion in its cloud business. As I mentioned above, cloud business is where the company is looking to achieve growth as it is one of the most lucrative business segments at the moment. The revenues from cloud business have increased 69% during 2013, one of the reasons that allowed the company to post an increased net profit while the revenues were falling. As further investment kicks in, this figure would likely grow this year and may increase the profits of the company significantly.
However, Watson business unit is still showing slow growth as it has only managed to bring in $100 million in revenues since 2011. Nonetheless, the management remains optimistic that they have figured out a way to use this technology to drive future profits. Further, IBM forecasts that its revenues from data analytics, which Watson is a part of, will increase by 25% to $20 billion.
Share Buy Back Plan: An Important Part of the Strategy
Share repurchase plans are a strategic tool for the management to play with the capital structure as well as a tool to pay back cash to share holders. Usually, a share repurchase plan is started when the management feels the stock is cheap in the market, or the management wants to put the cash piles of the company into a better strategic use - sometimes to increase the EPS by decreasing the share count. Now, IBM has been buying back shares before the management set a target of $20 in EPS by 2015. However, the level of spending on share repurchase has almost doubled since 2009. At the end of 2009, IBM's results showed $7.4 billion spent on share repurchases, which has gone up to $13.8 billion by the end of 2013.
The elevated level of spending on share repurchases has allowed the company to show growth in EPS at a higher rate than the growth in its net income. IBM is generating about $17 billion in operating cash flows and about $13 billion in free cash flows - so, keeping in mind the cash flows of the company, one can say that the share repurchase plan can go on and enhance the EPS of the company. In my opinion, the focus on the lucrative segments, restructuring of the underperforming segments, and efficient use of the cash to manage the share repurchase plan will allow the company to meet its target of $20 in EPS by 2015.
IBM shareholders need to be patient, in my opinion. It is true that the stock has been losing value of the past few quarters; however, I believe the long-term direction of the company makes it an attractive investment. The growth in the cloud and software segment is attractive and it will drive the future growth of the company. In the short-term, however, I expect the stock to underperform. As a result, this will not be a good investment for short-term investors.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. IAEResearch is not a registered investment advisor or broker/dealer. This article was written by an analyst at IAEResearch and represents his/her personal opinion about the companies mentioned in the article. The article is for informational purposes only and it should not be taken as an investment advice. Investors are encouraged to conduct their own due diligence before making an investment decision. I am not receiving any compensation (other than from Seeking Alpha) for this article, and have no relationship with the companies mentioned in the article.