IBM Does Not Compute Just Yet as a Buy

 | Apr 13, 2017 | 10:00 AM EDT
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IBM (IBM) reports first-quarter results on Tuesday after the market close. In late January, I wrote that I thought the stock was priced for perfection. With the stock off its 52-week high, could this report be a turning point? 

I maintained back in January that investors should wait for a better price for Big Blue. I noted that management was up to its usual tomfoolery -- i.e., a lower tax rate and massive share buybacks -- that it uses to hide the string of lousy quarters it keeps reporting. But investors like the track the company is on and are willing to suspend their disbelief until 2019.

Last month, I sat through IBM's analyst day and came away cautiously optimistic on the company's prospects. Management reiterated its long-term financial model of low single-digit revenue growth. While the timing was fuzzy, it seems the company is actually on track to post 1% to 1.5% revenue growth sometime in 2019. Of course, that's assuming 2018 is flat with 2017 and not another down year.

IBM believes computing is headed toward the "Cognitive Era" where there is so much data (44 trillion gigabytes by 2020) and so many devices (34 billion by 2020) connected to the cloud that some form of machine intelligence is needed to sort through all the complexity. That's where IBM's Watson comes in. Instead of just supplying hardware, IBM is determined to provide value-added solutions on top of its cloud offering.

In just the last five years, IBM has been awarded more than 4,000 patents in artificial intelligence and cogitative computing.

For example, in financial services, IBM acquired a company called Promontory, which has expertise in regulatory compliance and risk management. By training Watson on thousands of regulations, IBM can address the needs of an estimated $300 billion market. The company has 5,000 consultants helping financial institutions manage the regulatory environment and manage their risk using artificial intelligence. IBM said 28 of the largest global banks already are using the IBM cloud.

In health care, Watson has a managed dataset that includes 100 million health records, 200 million insurance claim records and more than 30 billion images. The company has 7,000 employees, including doctors and health policy experts, helping to solve problems in a market valued at an estimated $200 billion. In addition to care solutions, the company is training Watson in oncology and the life sciences. IBM already has 10,000 clients and more than 35 systems using Watson for oncology.

In computer security, IBM has 500 institutions in 55 countries using Watson to counter hundreds of millions of security threats per day. The company has more than 8,000 employees and 12,000 customers in its cybersecurity business. Watson has been trained in billions of data elements and millions of documents to address security issues in real time instead of the hours it takes a human.

IBM already has 200 million monthly active users consuming its weather intelligence.

By the end of 2017, management estimates Watson on the IBM Cloud will be available to more than 1 billion people.

Analysts are expecting IBM to report first-quarter 2017 earnings of $2.35 per share on $18.35 billion in revenue, which is essentially flat with last year. For the full year, analysts are looking for revenue of $78.6 billion, down 1.5% year over year, and earnings of $13.78 a share.

Right now, IBM is sitting at around 12x estimates, which is a discount to its peers at 15x. For the stock to move much higher, the company must post better operating margins or higher-than-expected growth. In the company's guidance, management already assumed Congress would lower taxes, so a lower tax rate shouldn't help that much. (IBM already pays a very low 12% rate.)

Even though IBM is a few points off its 52-week high, I don't feel any urgency to buy the stock. The shares seem fully valued for a story that won't play out until 2019. For me, IBM does not compute right now.

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