We place a mid-point valuation of $119.74 per share on IBM (NYSE:IBM), with a sensitivity range of $113.71 to $125.92. This valuation range is noticeably higher than the current market price of $105.16 per share.
Over recent years IBM has undertaken a series of acquisitions and divestitures that have resulted in a significantly change in the company’s business focus. This restructuring was a conscious move away from a number of IBM’s traditional product lines that it saw being commoditized (e.g. sale of Personal Computers business to Levono in 2005). In 2006 IBM completed 13 acquisitions valued at $4.8 billion, these acquisitions focused on growing IBM’s software and services businesses. These acquisitions are part of a wider strategy:
The company is continuing to refocus its business on the higher value segments of enterprise computing—providing technology and transformation services to clients' businesses. Consistent with that focus, the company continues to significantly invest in growth opportunities as a way to drive revenue growth and market share gains. Areas of investment include strategic acquisitions, primarily in software and services, focused client− and industry−specific solutions, maintaining technology leadership and emerging growth countries such as China, Russia, India and Brazil.
IBM 10-k 2006
IBM’s current operations can be divided into three principal business segments: services, software and systems and financing.
DCF Valuation Assumptions
Our mid-point valuation assumes IBM's revenue grows to $103 million in 3 years; this represents a compounding annual growth rate of 3.9%. As IBM increases its software sales EBIT margins are projected to improve to 15.9% (from 14.0% in 2006). We use a cost of capital of 9% and a terminal growth rate of 3%.
Comparable Company Analysis
Our mid-point reflects an EV/EBIT multiple of 14.9 compared to the current market EV/EBIT multiple of 13.2. It is difficult to identify a comparable company with a similar mix of business units to IBM. We have identified a number of companies that compete with IBM to varying levels.
Accenture (NYSE:ACN) – EV/EBIT 16.8 Accenture is global firm operating in 49 countries that specializes in management consulting, systems integration and technology and outsourcing services. Accenture has an enterprise value of $30.85 billion and EBIT of $1.84 billion in FY2006.
Electronic Data Systems (NASDAQ:EDS) – EV/EBIT 18.0 EDS provides information technology and business process outsourcing services in 64 countries around the world. EDS had $816 million EBIT in FY2006 and has an enterprise value of $14.!
SAP (NYSE:SAP) – EV/EBIT 16.4SAP specializes in providing enterprise software solutions to corporations, government agencies and educational facilities around the world. In 2006 SAP had EBIT of $2.56 billion and currently has an enterprise value of $41.88 billion. These comparable companies provide a reference point for IBM's EV/EBIT multiple but do not sufficiently reflect IBM’s overall business mix to validate a comparable company valuation.
IBM’s ability to achieve the short-term financial projections we've applied will depend largely on their ability to grow the software segment of the business and penetrate emerging markets. The higher margins provided by the software segment are a key driver of the projected EBIT growth. IBM faces competition in each of its business segments but the growth assumptions used are not overly aggressive and IBM is well positioned to focus on these opportunities following the recent restructuring. Overall, we believe that the current market price of $105.16 undervalues IBM.
IBM 1-yr chart