- Believing IBM's (IBM +5.7%) current valuation doesn't reflect the company's efforts to grow its cloud/analytics exposure, Morgan Stanley's Katy Huberty has upgraded to Overweight and set a $140 target.
- Huberty: "IBM Strategic Imperatives - data, cloud, engagement - now make up 35% of revenue and grew 17% in 2015, or 26% at constant currency, reflecting a faster-than-expected transformation to higher growth / higher value solutions. For comparison, Microsoft Cloud (Azure + Office 365) accounted for 36% of revenue and grew 20% in 2015. Yet IBM's share price reflects a perpetual decline in residual income, and these higher growth categories are undervalued based on our sum-of-the-parts (SOTP) analysis."
- Of note: While IBM's Strategic Imperatives revenue rose 17% in 2015, total revenue fell 9% (1% exc. forex) after adjusting for divestitures. Free cash flow rose by $700M Y/Y to $13.1B, but is forecast to drop to $11B-$12B in 2016.
- Regardless, Huberty expects the perceived disconnect between IBM's growth efforts and valuation to correct itself with the help of disclosures at IBM's Feb. 25 analyst day, stabilizing revenue, and improving free cash flow. She goes as far as to argue IBM "warrants a premium over other hardware companies that haven't invested heavily to transform to new computing paradigms," and predicts the company will deliver 2% annual free cash flow growth over the next two years (better than a consensus of -5%).
- Following Huberty's upgrade and news of the $2.6B Truven Health Analytics deal, IBM is a large-cap standout on a morning markets are nearly flat. Shares are now up 14% from last Thursday's 52-week low of $116.90. They trade for 9.4x a 2017 EPS consensus of $14.16.