Now Is The Time To Buy IBM Shares

| About: International Business (IBM)

Summary

In 2016, IBM is due for a re-rating.

Investors will start valuing the company as a software leader rather than a legacy hardware player.

Thematically, it will become a leader in artificial intelligence, Big Data, cybersecurity and the cloud.

IBM Is One Of My Top Technology Picks For 2016

In 2016, IBM's (NYSE:IBM) shares are due for a re-rating - investors will start to value the company as an emerging software leader rather than a legacy hardware player.

Like SAP AG (NYSE:SAP) and Oracle (NASDAQ:ORCL), many of IBM's legacy businesses - especially Enterprise Resource Planning systems - are struggling to adapt to a world moving rapidly to cloud-based services. The company is at the final stages of a difficult transition, but most of the bad news around this transition is now in the price of IBM's shares.

Thematically, IBM Will Soon Be Firing On All The Right Cylinders

Whilst revenues continued to decline in 2015 by 9% (or 1% after stripping out forex), IBM's investment in a host of next-generation technology platforms is set to pay off handsomely in 2016.

"Strategic Imperatives" revenue - which accounted for 13% of its total revenue in 2009 - now makes up 35% of total revenue and grew 17% in 2015. This division, in my view, is set to beat analyst expectations in 2016.

Moreover, the advanced technologies in which IBM has chosen to invest - Big Data, the cloud, cybersecurity, artificial intelligence, blockchain technology and the Internet of Things - are exactly the right ones.

Listed below are some of the themes in which IBM will likely show leadership over the next two years. Many are advanced next-generation technologies where first-mover advantage and scale will help generate supernormal profits.

Industrial Internet

The "Industrial Internet" is one of the five market segments that fall under the umbrella term, the "Internet of Things". The other four are wearable technology, ambient commerce, the automated home and the autonomous vehicle.

Whereas Apple (NASDAQ:AAPL), Alibaba (NYSE:BABA), Amazon (NASDAQ:AMZN) and Google (NASDAQ:GOOG) (NASDAQ:GOOGL) are focusing on the Consumer Internet, IBM is at the forefront of the Industrial Internet. Standards for the Internet of Things have not yet been set, so it is difficult to choose winners. But IBM - together with Cisco (NASDAQ:CSCO) and GE (NYSE:GE) - has become one of the most influential players in the standard setting process.

The value chain for the Industrial Internet can be split into four layers:

  1. The chip layer (microprocessors and sensors that collect data);
  2. the connectivity layer (edge devices such as routers and gateways that act as the first point of entry into a data network);
  3. the data layer (data analytics, cloud infrastructure, data security, networking and storage); and
  4. the control layer (industrial applications and operating systems).

IBM is a leader in the "data" and "control" layers for the Industrial Internet. Its closest competitor in the control layer is General Electric. In 2016, investors will hear more about IBM's Adept platform for the Industrial Internet. Adept is being co-developed with Samsung (OTC:SSNLF) and incorporates IBM's cloud infrastructure, Big Data analytics, artificial intelligence, cybersecurity and blockchain technologies.

Artificial Intelligence

The next generation of advanced technologies require artificial intelligence to enhance their performance. AI will become the "mother of all software" and those that own the leading AI platforms will have tremendous competitive advantage.

The value chain for artificial intelligence technologies can be split into five segments:

  1. Expert systems (e.g. smart grids);
  2. autonomous robots (e.g. delivery drones);
  3. virtual office assistants (e.g. Apple Siri);
  4. embedded systems (e.g. the Oculus Rift virtual reality headset); and
  5. neurocomputers (e.g. IBM's Watson "cognitive" supercomputer).

IBM is a leader in the "expert systems" and "neurocomputer" segments. But it is also investing in the other three AI segments.

Watson is now an evolving cloud-based platform for all-comers to tap into "always-on" intelligence via phones, laptops, data servers. Watson understands natural language and can work, therefore with unstructured data as well as pictures and can deal with hundreds of "AI" instances at once spread across a Cloud of open-standard servers. It has gone "live" at, among other places, Memorial Sloan Kettering Cancer Center where it helps clinicians suggest treatments.

Watson is designed to become the operating system for cognitive computing. It has a significant lead on rivals Apple, Google, Amazon and Microsoft (NASDAQ:MSFT). And IBM's Power8 chip architectures are the market-leading platform for most of the High Performance Computing (HPC) stacks that sit behind the world's most powerful supercomputers.

Combined with IBM's acquisitions in the healthcare space, it sets the company up to become a leading player in the "intelligent healthcare" industry, among others.

Cloud Infrastructure

IBM is the third largest global provider of cloud infrastructure-as-a-service (IaaS) after Amazon and Microsoft. We have consistently argued over the last six months that the importance of cloud infrastructure is grossly underestimated by investors. It is likely to be far more profitable than most analysts predict. And barriers to entry are already very high.

The reason for its importance in the future is simple. Cloud infrastructure is the foundation on which the next generation of technology cycles - from Big Data to mobile commerce to the Internet of Things - will sit. In a sense, cloud infrastructure acts as the operating system for accessing cloud services in the same way that Apple's iOS or Google's Android are the dominant operating systems for accessing the mobile Internet.

Amazon is the global leader in cloud infrastructure with a 29% market share. Microsoft has a 10% share, IBM 7%, and Google 6%.

Cybersecurity

Cybersecurity is the weak point in the IT systems of many of the world's top multi-national corporations. The most profitable part of the cybersecurity value chain for 2016 is likely to be "unified threat management" (i.e. managing multiple security functions in a single system) and defending against "zero day attacks" (i.e. vulnerabilities that a company's IT staff are unaware of at the time of attack).

IBM is strong in both segments of the market and is likely to get stronger in 2016 as a trusted name in this area.

Blockchain Technology

IBM has developed its own blockchain technology. The blockchain is the concept behind the public ledger system that validates the cryptocurrency, Bitcoin. However, rather than generating Bitcoins, IBM's blockchain technology can be used to keep track of business-to-business, bank-to-bank, and bank-to-business transactions as well as enforcing smart contracts. Blockchain technology is also an integral part of IBM's Adept platform for the Industrial Internet.

Software Defined Networking

Every 25 years or so, telecom networks get totally redesigned. The last big rebuild came with the Internet in the early 1990s. Now "IP networking" technology is giving way to another technology cycle known as "software defined networking". SDN is a new architecture for telecom networks in which the emphasis shifts from hardware to software. It will be hugely disruptive because it fundamentally changes who controls the telecom network.

Cisco, the largest and most profitable networking equipment maker for the IP networking world, has the most to lose. Its market share of over 50% and its margins are under threat from a host of start-ups.

The key to success in an SDN world is the ability to write the software that controls telecom networks and to design the chips that power them. IBM is writing the middleware that will bridge much of the old world to the new "software defined" world.

The SDN revolution, however, has been slow to take off, so its impact on IBM will be four to five years away. Yet, early leadership in this space could be another string to IBM's bow.

Disclosure: I/we 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.