2023-12-18 12:36:06 ET
Summary
- International Business Machines Corporation continues to miss the opportunity to monetize Watson's AI technology and lacks a real growth initiative.
- The company's Q3 earnings call revealed limited actual revenues from generative AI software.
- Despite the recent AI hype and the Apptio deal, IBM's growth rate is fading and future growth estimates are not impressive.
- IBM stock already trades at 16x '24 EPS targets, and the predicted growth rates don't provide a compelling reason to buy the stock.
Watsonx was a leader in artificial intelligence ("AI") years ago, yet International Business Machines Corporation ( IBM ) fumbled away the opportunity to monetize this leading technology. The company still has an opportunity in AI working with other tech companies, but IBM has no real growth initiative. My investment thesis is more Neutral on the stock following the recent rally on AI hype.
Source: Finviz
AI Software Hype
The biggest concern with IBM is a history of not generating growth despite the advanced technology of Watson and other cloud technologies. During the Q3 '23 earnings call, the tech giant repeated the recent mantra of other enterprise AI software companies with discussions of a lot of potential growth, but limited actual revenues.
On the Q3 2023 earnings call , CEO Arvind Krishna proclaimed the following the booking for generative AI (emphasis added):
Our book of business in the third quarter specifically related to generative AI was in the low hundreds of millions of dollars . The interest is larger, with thousands of hands-on interactions with our clients.
IBM did report 5.0% revenue growth in the third quarter , but the company only beat analyst estimates by $70 million. The company didn't have quite the blowout report as the market suggested, with the big stock rally since the earnings report sending the stock jumping from the $130s to over $165 intraday recently.
The company closed the big Apptio deal on August 10 . The deal cost $4.6 billion in cash and added over $1 billion in revenues for the automation software business.
The stock appears to have surged in a misunderstanding of a big AI push for revenues to suddenly start growing after the prior few quarters saw revenues decline, par for the course for Big Blue. The company is guiding towards Q4 '23 revenues of ~$17.3 billion, suggesting growth closer to only 3%. Despite all the AI hype and the Apptio business, IBM is already watching the growth rate fade.
IBM guided Apptio to a 0.5 contribution to revenue growth with an early Q4 close and altered the contribution to 70 basis points based on closing the deal early. With a 2023 revenue target of $62 billion, the Apptio business adds about $1.2 billion in annual revenues.
Even with the additional revenue from Apptio and the AI hype, the Q4 guidance and consensus estimates for forward years aren't impressive. The consensus revenue numbers for the next few years don't top 3% at this point.
Even considering analysts aren't correctly factoring in the actual demand for generative AI software models from IBM, the tech company needs $600+ million in additional revenues to generate a 1 percentage point boost to growth. IBM would need upward of $5 billion in additional annual revenues to reach a 10% growth rate.
Risks Beyond AI
The stock already trades at 5-year highs without any real signs AI will drive superior growth for IBM. The stock is at about 16x 2024 EPS estimates of nearly $10.
A major risk here is that the CEO could come under fire for racial quotas. CEO Arvind Krishna appears to suggest Asians, along with whites, aren't a protected class, and managers have had bonuses impacted based on hiring to meet racial quotas, leading to questions about discrimination.
Whether or not this leads to any impacts on IBM or the employment of the CEO, the company doesn't appear as focused on hiring the most qualified employees. The market might rightfully question whether the lack of growth in IBM's watsonx and other hybrid cloud initiatives may be due to the lack of focus on hiring the most talented people
In addition, generative AI models are very expensive to develop, and IBM doesn't appear to be aggressively spending in order to capture the market. Without a more aggressive push into AI, the tech giant will likely remain in a low growth mode for the years ahead, while other companies generate massive growth from the new technology.
The natural reason IBM probably can't aggressively invest in new AI technology is the balance sheet . The tech giant ended the last quarter with a net debt balance in the $44 billion range, making competition against tech giants with large cash balances difficult.
Takeaway
The key investor takeaway is that IBM doesn't appear to have fundamentally changed despite promising AI technology from watsonx. IBM stock has already run $30 in the last few months on AI hype, and the upside potential is likely limited here.
For further details see:
IBM: Fumbling Away AI Potential