Is IBM Still a Great Asset to Your Portfolio?
International Business Machines has become that large and diversified tech company that is widely held by institutions and retail investors "just because." It's hard to find a reason to own this stock, as it quickly loses market share to many companies, including Hewlett-Packard and Amazon .
One metric says it all
We could spend hours breaking down the business of IBM, a company that generates more than $100 billion in annual revenue by offering a slew of services and products. But a simple glance at its revenue trends over the past 24 months gives a clear indication of where this company is headed.
If you want to find a quarter where IBM saw positive year-over-year growth, you'd have to go back seven quarters, or to April 17, 2012. On Tuesday, the company announced a 5.5% decline in revenue -- the worst in two years. That highlights both the acceleration of its revenue losses and the significant problems that this company is facing. While there are many problems we could discuss, let's look at two, in particular, that might make IBM a good short opportunity.
The disappearance of hardware
IBM has many struggling segments, but none are doing as poorly as its sales of hardware and chips. This is a major segment for IBM, one that accounts for about 15% of total revenue. In the fourth quarter, it saw a whopping 26% year-over-year decline. This drop shows a major acceleration in the rate at which this business is declining, as it fell 17% and 12% in the third and second quarters, respectively, in 2013.
Moreover, the segment is really starting to weigh on the company's margins. IBM earned a pre-tax profit of $200 million from this segment, a decline of $768 million from the year prior.
At the same time, Hewlett-Packard is starting to thrive in this particular industry. During its last quarter, it saw its first year-over-year gain -- approximately 2% -- in its hardware business for the first time in the Meg Whitman era.
For Hewlett-Packard, hardware is a bigger piece of its pie than for IBM. In fact, in HP's last quarter, IDC estimated that the company's market share rose 150 basis points to 28.1%, while IBM's fell 430 basis points to 23.4%.
Following this dismal hardware performance from IBM, it will be interesting to see how these numbers change, and more importantly, it'll be enlightening to hear how the company explains such a rapid loss in a very important segment.
With that said, HP is actually cheaper on a price-to-forward-earnings basis, and given these numbers, Hewlett-Packard is likely a far better investment for tech investors seeking value.
Don't let the cloud fool you
More than likely, IBM will try to take the focus off its falling hardware sales and total revenue and move it to the growth of its cloud business.
According to IBM, its cloud revenue grew 69% to $4.4 billion, and due to this strength, the company recently announced plans to invest $1.2 billion on up to 15 new data centers for the cloud. However, it is important to note that most of this growth came from its $2 billion acquisition of web-hosting business SoftLayer.
This acquisition has been criticized, since the web-hosting industry grew just 3%, year over year, in the third quarter. Many investors believe that IBM should have instead acquired a large cloud infrastructure, or laaS, company, or a company with a cloud app platform, or PaaS.
IBM is still primarily an on-premise IT company, with nearly $10 billion of its fourth-quarter revenue coming from global technology services, which also represents a 4% year-over-year decline.
Back in late November, hedge fund manager Stanley Druckenmiller called IBM a great short, saying that every dollar earned by cloud services like Amazon Web Services, is a dollar lost for on-premise IT companies like IBM. Given IBM's 4% loss in this business, we can see the truth in this statement.
Amazon's AWS was recently given a $50 billion valuation by Evercore. It's a segment of Amazon's business that is expected to generate more than $8 billion in 2014. Moreover, Synergy Research estimates that AWS is growing at an annualized rate of 55%, which is great news for Amazon, but not good for IBM.
This news affects IBM in two ways. First, the rapid growth of laaS and PaaS proves that IBM made a bad bet on SoftLayer and its 3% year-over-year industry growth. This suggests that IBM's large year-over-year cloud revenue will soon cease to exist.
Second, if Stanley Druckenmiller is correct, and AWS's growth takes away from on-premise IT, then we can certainly expect further fundamental declines from IBM, and likely larger gains for Amazon.
IBM is a well-known name, and to many, a doomsday scenario just doesn't seem likely. Furthermore, at just 13 times earnings, many will argue that IBM is cheap relative to a market that's trading at 16 times earnings.
The problem with this logic is that IBM is a major tech company that is seeing significant fundamental declines in a market that is growing. It is not worthy of the same multiple as its peers, and there are real reasons to believe that these problems could linger.
Maybe there is a valuation multiple where such a stock becomes attractive. But, without knowing the bottom to IBM's fundamental woes, investors might find the value in stocks such as Hewlett-Packard far more rewarding.
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The article Is IBM Still a Great Asset to Your Portfolio? originally appeared on Fool.com.Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com and International Business Machines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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