IBM’s 4Q19 earnings report was a big step in the right direction for Northlake’s bullish thesis on IBM shares.  As a reminder, we see the potential for an expansion in the company’s depressed P-E multiple if the company can return to modest revenue growth due to improvement in the company’s growth businesses – hybrid cloud, artificial intelligence, consulting, and software and services.  The combination of many years of internal restructuring and investment and the acquisition of Red Hat as an accelerant have the potential to move the company back to low to mid single digit revenue growth.  A similar transition was made at Cisco Systems beginning in 2017 and that stock’s P-E multiple expanded from 10X to 15X allowing the shares to climb more about 70%.  We see IBM’s 4Q results as the first step toward following a similar path.  IBM still has much more to prove but at less than 11X newly issued 2020 EPS guidance the shares offer considerable upside.  At 13X 2020 guidance, the shares would trade at $173, up 25% from the close immediately prior to the 4Q earnings report.

In 4Q19, IBM produced 3% overall revenue growth, a nice acceleration from recent quarters.  Key growth initiatives came through and the challenging businesses lines in the company’s legacy hardware businesses stabilized their rate of decline.  Importantly, the acquisition of Red Hat is working form a strategic and financial standpoint.  Strategically, Red Hat’s open source platform is being sold into IBM’s large installed base, while the platform also pulls legacy IBM customers into the company’s hybrid cloud products and services.  Management noted 50 new engagements thanks to Red Hat.  Financially, Red Hat’s internal growth has accelerated, which along with the new revenue being generated by IBM’s legacy enterprise customer base has led to a pickup in overall corporate revenue growth.

The quarter was not perfect and the guidance assumes a lower tax rate and back-half weighted 2020 financial performance.  IBM needs to build upon the 4Q19 report with several more quarters similar to 4Q19.  Greens shoots are evident.  Time will tell if they bloom into flowers but so far so good.

IBM is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.