IBM

Moat: 3/5

Understandability: 4/5

Balance Sheet Health: 4/5

A multinational technology company that is a major player in hybrid cloud and AI and provides a diverse range of solutions through a consulting business and other services.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: IBM, or International Business Machines, is an IT giant that primarily earns revenue from the following segments:

  • Software: Includes software products and solutions such as hybrid cloud platform, data platform and AI software, automation, and security software. In recent times, we’re seeing strong demand for its hybrid cloud, data platform and AI software products.
  • Consulting: Delivers professional services, business transformation solutions, and technology implementation. This area is currently seeing very strong growth and high demand for services.
  • Infrastructure: Offers hardware, software, and services that enable digital transformation.
  • Financing: A lending arm of the company that provides financing primarily to IBM’s clients.

IBM’s business model is evolving, with a greater focus on high-margin software and consulting services over legacy hardware offerings. The company is betting heavily on hybrid cloud solutions and AI to drive its next phase of growth.

Industry Trends:

  • Hybrid Cloud: Businesses are increasingly embracing hybrid cloud strategies to benefit from both private and public clouds. This trend plays favorably into IBM’s hands, as its solutions target these environments. IBM is very well positioned in this space and this could become its moat in the future.
  • AI and Analytics: The rapid adoption of AI and advanced data analytics provides a significant tailwind for companies with expertise in this area. IBM has some good solutions in this space, but its AI adoption in its products still has a long way to go.
  • Digital Transformation: Businesses are undergoing massive digital transformations. This means they require modern enterprise software, data, security, and other services, which directly benefits companies like IBM.
  • Cybersecurity: Data breaches and cybersecurity threats are rapidly increasing, which means that security is a high priority for all businesses, and provides high demand for these products.
  • Supply Chain Disruption: The global supply chain continues to be volatile, which is forcing companies to become more resilient.

Competitive Landscape:

  • Software: IBM competes with a wide array of competitors, such as Microsoft (especially in the cloud space), Oracle (databases), SAP (enterprise resource planning), and other niche software providers. Many of these companies are big and have great technical abilities, meaning competition is extremely fierce.
  • Consulting: The consulting space is also very competitive and features a lot of players, such as Accenture, Deloitte, Infosys, and a number of smaller firms.
  • Infrastructure: IBM competes with a variety of big players, such as Amazon (AWS), Microsoft (Azure), and Google Cloud. These tech giants are rapidly gaining more marketshare and pose a significant threat to IBM’s position in hardware infrastructure.

What Makes IBM Different?

  • Brand Legacy: IBM has a deep and reputable history in technology, but its brand awareness in the consumer market is minimal, despite it being one of the oldest tech giants.
  • Focus on Enterprise Solutions: IBM is focused on enterprise solutions, which means that it caters to a large and diverse set of businesses and organizations.
  • Hybrid Cloud and AI Leadership: IBM is positioning itself as a leader in hybrid cloud and AI solutions, but they are yet to fully materialize to be a main driver of revenue.
  • Global Presence and Reach: As a true multinational, IBM has a massive global presence with a large customer base and a vast sales force, as well as great technical talent.
  • Strong Research and Development: IBM is known for its impressive research and development facilities which gives a sense of high-quality product and service offerings.

Financial Deep Dive:

  • Recent Revenue Trends: IBM has seen recent improvements in revenue and in the last few quarters, it has mostly met its growth targets.
  • The company beat revenue estimates in the first quarter of 2024 and also raised its revenue guidance for the full year 2024.
  • Total revenue for the second quarter of 2024 was $15.5 billion, with revenue growth of 0.4 percent, and 1.9 percent in constant currency.
    • The best performing segment was Consulting, which grew by 7 percent, or 8.3 percent in constant currency.
    • The worst performing segment was Infrastructure, with revenue declining by almost 6 percent.
    • The company reported 5 percent revenue growth from the Software segment, or 6.6 percent in constant currency.
    • It is also important to note that IBM’s growth is heavily tied to IBM’s consulting arm, which makes up for most of IBM’s organic revenue growth.
  • Margins: IBM’s gross profit margins in the second quarter of 2024 were at 54.4%, and net income margin at about 20% (including gains from sales), showing that despite the huge shift in focus to software over other segments, the company is still very profitable.
    • While IBM has seen increases in profits and revenue, it must keep up the momentum in these high-growth sectors in order to remain competitive.
    • Operating margins also continue to fall, since they’ve been reduced by one to two points since the start of 2024.
  • Capital Structure: IBM is focused on having a strong balance sheet and generating stable cash flows.
    • IBM is focusing on reducing its debts, and has continued to reduce its interest expense over time.
    • The company also pays substantial dividends and does a good amount of share buybacks.
  • Cash Flow: The company is a strong free cash flow generator.
    • Free cash flow for the second quarter was $2.1 billion, and the company expects $11 billion in free cash flow for 2024.

Risks:

  • Competition: The highly competitive tech industry is a major risk for IBM and means that it needs to consistently innovate to stay competitive.
  • Transition risk: IBM’s ongoing transition to a cloud-focused business has brought some difficulties and financial difficulties. For example, IBM has been known to report some rather large losses related to non-performing projects, especially in its consulting segment.
  • Talent Retention: The company has had issues with talent management. Competitors, many of which are in Silicon Valley, can quickly draw away technical talent, which would cause a further downturn in IBM’s competitiveness.
  • Global Uncertainties: High inflations, currency rate fluctuations, and wars/conflicts are all factors that IBM is exposed to and that could lead to significant losses.

Moat Rating: 3/5 IBM possesses a narrow moat, mostly due to switching costs and scale within its enterprise solutions. However, the competition in the areas in which IBM is trying to grow (Cloud, Cybersecurity, and AI) is extremely fierce, and thus its competitive advantage is at risk. The lack of a dominant position in many of its products also further limits the moat. The moat could potentially widen in the future due to strong demand for hybrid cloud solutions, if IBM can position itself as a market leader in this segment.

Understandability: 4/5 IBM has a complex business structure with many moving parts, and the market they operate in is a quickly evolving one. While some of their older business lines such as infrastructure and software are fairly straightforward, their new offerings into cloud, AI, and consulting, are quite complex. However, a general understanding of their main business areas, and the shift in their offerings is readily available, which makes the company fairly easy to understand.

Balance Sheet Health: 4/5 IBM has a reasonably healthy balance sheet with a well-managed amount of debt and consistently improving free cash flows. The company is in good financial health, but its financial structure is complicated with a lot of financial engineering to be taken into consideration, which is why it gets a 4 rating instead of 5.

  • Recent Concerns/Controversies/Problems:
  • IBM has faced issues surrounding its consulting business, which has incurred losses due to underperforming projects. The company is addressing this by trying to improve efficiency of its consulting practices and better client segmentation.
  • IBM is also facing increasing competition in its high-growth sectors, but management has expressed confidence in being able to compete successfully.

The management believes that it will still be able to hit its financial targets for 2024 and they stated that the current environment is favorable for a return to growth.