2023-12-16 08:30:00 ET
Summary
- IBM's recent recovery has defied doubts about its ability to reignite growth, surging over 22% since its October lows.
- The company's focus on generative AI and open-source approach aligns with the industry's direction and helps alleviate concerns about its innovation.
- IBM's strong profitability, hybrid cloud approach, and consulting business support its growth and potential to recover its long-term uptrend.
- I argue why I'm increasingly convinced about IBM's long-term turnaround thesis. As a result, I'm no longer skeptical about investors catching a falling knife.
- IBM's next steep pullback could provide a fantastic opportunity to buy.
My last update on International Business Machines Corporation (IBM) coincided with IBM struggling for upward momentum at a critical juncture below the $153 resistance level. While I acknowledged IBM's solid IT business and robust software margins, I suggested investors consider reassessing a buying opportunity at its next steep pullback.
That pullback arrived in October, as IBM fell to the $136 level before bottoming out. However, IBM dip-buyers helped defend against a further collapse, as they returned aggressively following the company's third-quarter or FQ3 earnings release .
That dip-buying opportunity proved to be IBM's bottom before it surged more than 22% through this week's highs, defying skeptics about its ability to reignite growth. As a result, I believe it's apt for me to help investors reconsider whether it still makes sense for them to chase potential upside from the current levels.
IBM's recent recovery is pivotal, as it re-tested levels not seen since early 2018. As a result, it could herald the start of a remarkable turnaround in its fortunes as the company embarks on making generative AI part of its core growth strategy. IBM's generative AI offering is predicated on watsonx as the " core platform that enables clients to train, tune, validate and deploy AI models." watsonx is based on an open ecosystem approach, emphasizing the importance of " collaboration and openness in AI development." Accordingly, IBM formed a partnership with Meta Platforms (META) to develop an AI alliance that includes "over 50 companies, research groups, and academic institutions."
I believe the company's approach aligns with the state of AI development, as the industry increasingly focuses on the open-source approach. Such an approach is pivotal to thwart the walled-garden advantages of proprietary AI systems, as they leverage their network effect moat to lock in customers at an early stage. Therefore, IBM is seen as a leader in the open source space, alleviating investors' concerns that IBM could be an AI dinosaur that could find trouble innovating.
Moreover, these bearish investors could have forgotten that IBM boasts a best-in-class "A+" profitability grade, supporting its ability to invest in bolstering growth. Its hybrid cloud approach with Red Hat helps its customers transition to a cloud computing environment more securely, allowing them to scale their workloads efficiently. Management " foresaw a multienvironment approach," optimizing workloads across "public, private, on-premises, and edge environments." Coupled with its industry-leading consulting business, it helps to sustain significant cross-selling momentum across several segments. With watsonx driving customers' interest in deploying AI models, it has also bolstered the growth of its consulting business.
As a result, IBM has astutely monetized its consulting business to leverage the secular shift in AI, as it "supports clients in deploying gen AI solutions." As a result, management is confident in the adoption curve for its gen AI products, developing a "$1 billion consulting business around gen AI," which is expected to continue expanding further.
Therefore, I'm not surprised that AI investors could have anticipated the opportunity to gain exposure to IBM, given its relatively inexpensive valuation.
Seeking Alpha's Quant still assigns a "B-" valuation grade, notwithstanding its recent surge. Its forward EBITDA multiple of 12.4x is above its IT services peers' median of 11x. However, as investors re-rated its transformation, IBM last traded well above its 10Y average of 9x.
I believe the market will likely emphasize its software services growth momentum, which delivered 8% growth in Q3. Its SaaS peers have a median EBITDA multiple of about 23x, suggesting an implied undervaluation. Based on Trefis' sum-of-the-parts or SOTP valuation framework, software accounts for about 62.4% of IBM's valuation, corroborating well for a re-rating.
As a result, I believe it's apt for investors to consider whether the turnaround in IBM could lead to a long-term secular uptrend bias, given the recent developments.
IBM price chart (monthly) (TradingView)
With IBM re-testing its January 2018 highs on its long-term chart, I believe the stage seems to be set for IBM's long-term recovery.
IBM dip-buyers have attempted to support its consolidation over the past four years, as it bottomed out at the $87 level, which marked its COVID lows.
However, the conviction of a secular uptrend has consistently faced significant resistance below the $150 level.
As a result, the ability of recent buyers to break above that level toward a multi-year high is pivotal from a price action perspective. While a pullback is anticipated and warmly welcomed, I have a higher conviction that buyers considering buying the dips at its subsequent pullback can do so with more aggression.
The market seems confident about IBM's long-term shift, driven by its gen AI offerings and the robust underpinnings of its hybrid cloud and consulting business. Consider waiting patiently for the recent enthusiasm to be digested before re-entering if you missed its October lows.
Rating: Maintain Hold.
Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.
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For further details see:
IBM: Defying Massive Skepticism As It Surged Above A 5-Year High