SPINNING WHEEL
Courtesy of Almost Daily Grant's
Top of the heap no more. International Business Machines Corp. reported third quarter earnings on Monday, including $17.56 billion in revenues. That’s down 2.6% from a year ago and 3.1% sequentially and the weakest result since the first quarter of 1997.
While $2.58 in headline earnings per share was down 4% from a year ago, a series of salutary one-time adjustments spruced up that figure, which was 27% above the $1.89 per share derived from generally accepted accounting principles. Even those GAAP results were flattered by a meager 7% corporate tax rate. In 1985, when then-dominant IBM commanded a 6.4% share of the market cap-weighted S&P 500 (a record single-stock concentration until this year), Big Blue paid out 44% of its bottom line in taxes.
With three quarters of its 2019 revenue base (the information technology infrastructure hardware, software and sales units) under pressure thanks to widespread adaptation of the cloud, you can’t say that IBM is sitting on its heels. After completing a $34 billion acquisition of open source software provider Red Hat in July 2019, the company announced Oct. 8 that it will spin off its legacy managed infrastructure services unit. CEO Arvind Krishna explained: “This will accelerate our growth strategy and better position IBM to seize the $1 trillion hybrid cloud opportunity.”
That rationale is understandable, as the I.T. services unit, which includes the soon-to-be-spun-off division, endured a 6.1% revenue decline in 2019. The move earned the rousing approval of Mr. Market, as shares closed higher by 6% on the day of the announcement, but good days for the bulls have been few and far between. Since a bearish analysis in the Feb. 21 edition of Grant’s, IBM shares have lost 21% after accounting for dividends, compared to a 5% gain over the S&P 500.
While shedding that growth albatross is seemingly a positive step, other concerning signs abound. For instance, IBM’s global business services (i.e. management consulting) revenue registered just $4 billion, down 5% from a year ago, a concerning sign as the division should be largely inured against the cloud craze. Even the 19% top-line expansion from the cloud unit was well below the 30% year-over-year revenue growth logged in the second quarter.
Analysts remain circumspect, with six Wall Street analysts rating IBM shares “buy” while 12 judge the stock either a “hold” or “sell.” Following Monday’s earnings report, Keith Bachman of BMO Capital Markets wrote that “underlying business conditions remain weak such that patience will be required, particularly since the spin-off is a year away,” while Bloomberg Intelligence’s Anurag Rana concludes that the flagging top line “may not see any dramatic improvement until the second half of 2021 at the earliest.”
Then, too, efforts to bolster cloud unit growth haven’t come cheap, as IBM coughed up fancy valuation for Red Hat (10 times revenues, 53 times Ebitda and a 63% premium to the target’s pre-bid closing price). That’s pushed single-A-rated IBM’s net leverage to 2.9 times consensus 2022 adjusted Ebitda, up from 1.5 times Ebitda prior to the deal announcement and 2.0 times net leverage for the median single-A-rated corporate issuer, according to a September analysis from Moody’s. IBM’s net leverage can be expected to drift still higher, if form holds. Thus, Street consensus currently calls for $18.8 billion in adjusted Ebitda next year, down from a $20 billion 2021 Ebitda guesstimate a year ago.
Perhaps most concerningly, fast-deteriorating cash generation has further hampered management’s efforts to turn the ship around. IBM generated just $1.1 billion in free cash flow in the third quarter, far below the $2.3 billion analyst consensus and well short of the $1.5 billion in dividends paid out over the same period.
Might IBM be facing an extended stay in corporate stagnation purgatory? Bernstein analyst Toni Sacconaghi noted Tuesday that while CEO Krishna thinks IBM can grow “mid-single digits” by 2022 following the I.T. spin-off, organic revenue declined 6% in the third quarter from a year ago and has fallen by a meaty 11% so far this year. Such a massive top-line turnaround “seems ambitious given that IBM management stated that 70% of its revenues were largely unaffected by the pandemic” in the third quarter. Bernstein “continues to believe that IBM’s normalized growth rate today is -1%,” and “might be 0% to 1% post its spin-out.”
The slog continues.
QE PROGRESS REPORT
The printing press is heating up anew, as Reserve Bank credit jumped to $7.11 trillion, up $65 billion from a week ago. That pushed the three-month growth rate of interest bearing assets at the Fed to 7.5% from 4.9% a week ago, even as the year-over-year comparison continued to edge lower, reaching 80.2% growth this week compared to 81.1% on Oct. 15.
RECAP OCT. 22
Rates were routed once more, as Treasurys came under pressure across the curve again with the 30-year yield rising to 1.68%, its highest since mid-March. Stocks caught a moderate bid, with the S&P 500 finishing 60 basis points in the green to narrow its loss for the week so far to less than 1%. Gold pulled back to $1,907 an ounce, WTI crude crept up toward $41 a barrel, and the VIX slipped 2% to 28.
– Philip Grant
Ferris wheel image by Stephen Marc from Pixabay
