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Financial Analysis of IBM
Research · October 2016
DOI: 10.13140/RG.2.2.25518.10563
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FINANCIAL ANALYSIS
JAWAHER ALOTAIBI
ANTHONY DENINA
FANLONG MENG
1. Background Information
International Business Machines (IBM), nicknamed "Big Blue", is a multinational
computer technology and IT consulting corporation; headquartered in Armonk, New
York, United States. IBM has a continuous history dating back to the 19th century. It
manufactures and sells computer hardware and software with a focus on the latter.
IBM also offers infrastructure services, hosting services, and consulting services in
areas ranging from mainframe computers to nanotechnology (IBM, 2015).
With over 433,362 employees worldwide in 2012, IBM is one of the largest and
most profitable information technology employers in the world. IBM holds more
patents than any other U.S. based technology company and has eleven research
laboratories worldwide. Moreover, the company has scientists, engineers, consultants,
and sales professionals in over 170 countries (All jobs Ken, n.d.). When it comes to
IBM’s products, the Company operates five business segments: Global Technology
Services, Global Business Services, Software, Systems and Technology, and Global
Financing. Global Technology Services primarily provides IT infrastructure and
business process services (Reuters, n.d.).
Big Events
•
In June 2013, IBM acquired SoftLayer Technologies.
•
In July 2014, IBM partnered with Apple Inc. in mobile enterprise.
•
In August 2014, IBM acquired the business operations of Lighthouse Security
Group, LLC.
•
In September 2014, IBM sold its x86 server division to Lenovo.
•
In November 2014, IBM and Twitter announced a global landmark partnership.
•
In August 2015, IBM agreed to purchase Merge Healthcare for $1 billion,
incorporating Merges' imaging management platform with its Watson data
analytics tool.
1
Strategy
Due to business customers moving away from buying big mainframe computers
and traditional software, IBM has struggled with decreasing revenue over the past three
years. IBM substantially invests to develop new products, such as data analytics and
artificial intelligence programs and "cloud" software which the company delivers to
customers over the Internet. However, IBM’s new businesses have not yet grown as
much as the company hoped; revenue has continued to fall in its traditional software,
hardware and technology services businesses (Allen, 2015).
2. Financial Ratios Analysis
Financial ratios are one of the many tools stock analysts and investors use to
analyze a company or industry. No one consistently predicts stock price movements;
however, ratios often highlight a company's strength and/or potential weaknesses.
Financial ratios can also give mixed signals about the company's financial health and
can vary significantly among companies, industries, and over time.
Liquidity or Working Capital Ratios
Liquidity or Working Capital
Current Ratio
Quick Ratio
Working Capital (In millions)
2014
1.25
1.19
$9,822
2013
1.28
1.22
$11,196
2012
1.13
1.08
$5,808
2011
1.21
1.15
$8,805
2010
1.19
1.13
$7,554
Based on the above data, IBM’s current ratio has slightly fluctuated from 2010 to
2014. However, the company’s current ratio for 2014 indicates that it’s able to pay off
its short-term liabilities with its current assets; the company has 1.25 times current
assets than its current liabilities. This means that the company can make current debt
payments. In addition, the company’s quick ratio for 2014 shows that IBM has $1.19
of available liquid assets to cover each $1 of its current liabilities; IBM is able to meet
its short-term obligations with its most liquid assets (excluding inventories).
Moreover, IBM’s positive working capital ($9,822 million) for 2014 illustrates the
2
amount of money leftover once the company pays its current liabilities with its current
assets; its working capital has decreased from 2013 to 2014.
Efficiency and Asset Management Ratios
Efficiency and Asset Management
Total Assets Turnover Ratio
Fixed Assets Turnover Ratio
Days Sales Outstanding (DSO)
2014
0.79
8.62
35.76
2013
0.78
7.12
38.83
2012
0.86
7.35
37.85
2011
0.92
7.70
38.16
2010
0.88
7.08
39.60
IBM’s total assets turnover ratio shows the company has performed better than its
previous fiscal year. IBM is generating more revenue per dollar of assets; the
company is generating 79 cents of sales for every dollar invested in assets. The higher
the asset turnover ratio, the better the company is performing. In addition, IBM’s
fixed assets turnover ratio has increased by 1.5, which indicates that the company has
become more effective when it comes to investment in its fixed assets. This means
IBM is using the investment in fixed assets more effectively to generate revenues. A
dollar invested in fixed assets generates $8.62 revenue. Furthermore, the DSO
measures the average number of days IBM takes to collect revenue after a sale has
been made; the lower amount of days, the better. The company DSO has improved in
2014 comparing to its 2013 DSO. IBM takes nearly 36 days to collect cash from its
customers on average; the company has a short average turnaround in converting its
receivables into cash.
Debt Management Ratios
Debt Management
Total Liabilities to Total Assets
Long-Term Debt to Capital
Times Interest Earned (TIE) Ratio
2014
0.90
0.40
42.29
2013
0.82
0.39
51.36
2012
0.84
0.32
50.11
2011
0.83
0.32
52.10
2010
0.80
0.32
54.60
Total liabilities to total assets ratio depicts IBM’s debts has increased from 2013
to 2014 wherein the proportion of a company's assets are being financed with debt
3
(i.e. each dollar of asset has been financed by 90 cents of debt). IBM could pay all its
debts by using its assets but it would put the company in a difficult position with only
0.1 of its assets and a lower degree of financial flexibility. Moreover, the long-term
debt to capital ratio measures the financial leverage of the company. It calculates the
proportion of a company's long-term debt compared to its available capital. IBM’s
long-term debt to capital is 0.40. This illustrates that the company has more equity
than debts; 40% of the company’s total capitalization is long-term debts which is the
highest in the last five years. In addition, the TIE ratio calculates the amount of
income that can be used to cover the company’s interest expenses in the future. The
ratio indicates how many times IBM could pay the interest with its income (before
tax); the larger the ratio, the better. IBM’s TIE for 2014 means it has enough income
to pay for its total interest expense 42.29 times over; simply put, its income is 42.29
times higher than its interest expense for 2014. IBM’s TIE ratio has decreased from
2013 to 2014 by 9.07.
Performance Ratios
Performance
Profit Margins
Return on Total Assets (ROA)
2014
0.13
0.10
2013
0.17
0.13
2012
0.16
0.14
2011
0.15
0.14
2010
0.15
0.13
The profit margin ratio measures the amount of net income earned with each
dollar of sales; it shows the percentage of sales that are left over after all expenses are
paid and indicates how IBM can effectively convert sales into net income. IBM’s
profit margin for 2014 is 13% which means the company was able to convert 13% of
its sales into profits. The company’s profit margin has decreased in 2014 compared to
2013. Furthermore, IBM’s ROA shows the net income produced by total assets and
measures the company’s efficiency in managing its assets to produce profits. In 2014,
IBM’s ROA is 10% which illustrates that with every dollar the company invests in
assets, it produces 10 cents of net income. IBM’s ROA has decreased in the past few
years.
4
DuPont Ratio
𝑅𝑂𝐸 = 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛𝑠 × 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 × 𝐸𝑞𝑢𝑖𝑡𝑦 𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟
𝑅𝑂𝐸 =
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
𝑆𝑎𝑙𝑒𝑠
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
×
×
𝑆𝑎𝑙𝑒𝑠
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
𝐸𝑞𝑢𝑖𝑡𝑦
DuPont
Profit Margins (Profitability)
Total Assets Turnover Ratio(Efficiency)
Equity Multiplier (Leverage)
DuPont Ratio
2014
0.13
0.79
9.78
2013
0.17
0.78
5.50
2012
0.16
0.86
6.28
2011
0.15
0.92
5.75
2010
0.15
0.88
4.90
1.00
0.72
0.87
0.78
0.64
The DuPont ratio is based on the return on equity (ROE) ratio which is used to
analyze the company's ability to increase its return on equity. The DuPont analysis has
three main components of the ROE ratio: Profitability (Profit Margins), Efficiency
(Total Assets Turnover Ratio), and Leverage (Equity Multiplier). Based on these three
performances measures, the company could increase its ROE by: maintaining a high
profit margin, increasing asset turnover, or leveraging assets effectively. Therefore,
from the above table, IBM’s DuPont ratio has significantly increased over the past
five years which means the ROE ratio has increased. The company’s ROE for 2014
was 100% while it was 72% in 2013.
In addition, we compared IBM to its close competitor Microsoft. By taking into
account the above financial ratios, we determined that IBM’s current ratio of 1.25 is
less than Microsoft’s current ratio of 2.25. This is a similar case when comparing
IBM’s quick ratio; IBM’s quick ratio of 1.19 is less than Microsoft’s 2.44. From this
comparison, the data shows that Microsoft is doing better than IBM when it comes to
the Liquidity Ratios. However, when looking at the Assets Efficiency Ratios, IBM’s
total assets turnover ratio is 0.79 while Microsoft’s is 0.53; and IBM’s fixed assets
turnover ratio is 8.62 which is higher than Microsoft’s 6.35. This means that IBM is
managing its assets more efficiently than Microsoft. Furthermore, IBM’s total
liabilities to total assets ratio is 0.90 which is higher than 0.48 for Microsoft; IBM’s
long-term debt to capital is 0.40 which is also higher than 0.31 for Microsoft. Overall,
5
IBM has a larger proportion of its assets that are being financed with debt than
Microsoft. However, both companies have the same profit margins which is 0.13 but
IBM has higher return on its total assets with 10.23%; Microsoft's ROA is 6.92%.
When it comes to the DuPont Ratio, IBM’s ROE for 2014 was 100% while
Microsoft's ROE was only 15%.
3. Bond Valuation
Market Debt
IBM’s market debt in 2014 is $40,804 million ($35,073 million as long-term
debt, and $5,731 million as short-term debt). IBM’s debt has been constantly
increasing for the past three years. For 2013, its market debt was $39,781 million
($32,586 million as long-term debt, and $6,862 million as short-term debt); for 2012,
its market debt was $33,629 million ($24,088 million as long-term debt, and $9,181
million as short-term debt).
Average Maturity of Debt
The average maturity of debt refers to the average length of time for which the
debt is issued, at or by the end of which it must be completely repaid to the lender. It
is calculated by adding each debt's time to maturity and dividing by the total number
of debt products.
No.
1
2
3
4
5
Time
09/14/2017
02/12/2024
07/22/2016
11/06/2020
10/15/2018
Maturity
2.706849315
9.123287671
1.558904110
5.854794521
3.791780822
Amount $
3,000.000
2,000.000
2,000.000
1,694.000
1,600.000
% of TD
8.6%
5.7%
5.7%
4.8%
4.6%
Weighted Maturity
0.23
0.52
0.09
0.28
0.17
6
7
8
9
10
11
12
13
02/06/2018
08/01/2023
05/15/2020
12/21/2020
11/07/2025
05/26/2023
11/19/2019
06/20/2042
3.104109589
8.589041096
5.375342466
5.978082192
10.860273970
8.405479452
4.887671233
27.487671230
1,500.000
1,500.000
1,250.000
1,154.200
1,129.300
1,129.300
1,129.300
1,107.300
4.3%
4.3%
3.6%
3.3%
3.2%
3.2%
3.2%
3.2%
0.13
0.37
0.19
0.20
0.35
0.27
0.16
0.87
6
14
15
16
17
18
19
11/06/2021
01/05/2016
02/05/2016
02/08/2018
08/01/2022
05/06/2016
6.854794521
1.013698630
1.098630137
3.109589041
7.589041096
1.347945205
1,100.000
1,000.000
1,000.000
1,000.000
1,000.000
1,000.000
3.1%
2.9%
2.9%
2.9%
2.9%
2.9%
0.21
0.03
0.03
0.09
0.22
0.04
20
21
22
23
24
25
26
27
28
29
30
31
02/06/2017
02/12/2019
02/12/2019
11/01/2019
11/30/2039
11/29/2032
10/30/2025
05/15/2019
11/01/2021
02/06/2018
08/01/2027
08/05/2022
2.104109589
4.120547945
4.120547945
4.838356164
24.931506850
17.926027400
10.838356160
4.372602740
6.841095890
3.104109589
12.591780820
7.600000000
1,000.000
750.000
750.000
750.000
745.100
600.000
600.000
600.000
500.000
500.000
468.600
461.700
2.9%
2.1%
2.1%
2.1%
2.1%
1.7%
1.7%
1.7%
1.4%
1.4%
1.3%
1.3%
0.06
0.09
0.09
0.10
0.53
0.31
0.19
0.07
0.10
0.04
0.17
0.10
32
33
34
35
36
02/10/2017
12/01/2096
01/15/2028
10/30/2045
10/15/2038
2.115068493
81.975342470
13.049315070
30.852054790
23.805479450
377.100
336.400
313.000
27.000
2.062
1.1%
1.0%
0.9%
0.1%
0.0%
0.02
0.79
0.12
0.02
0.00
35,074.362
1
7.25
Based on the above data, the average maturity of debt is 7.25 Years.
Credit Rating
IBM’s credit rating is Aa3, AA-, and A+ respectively from Moody’s, S&P, and
Fitch. The high grade credit rating reflects certain financial risk. However, IBM's
business is strongly improving because of the company's shift to software and
services from hardware; software and services are a more stable and profitable
business (Yahoo Finance, 2012). Based on Moody’s, S&P, and Fitch, IBM is into the
category of high credit ratings. The below table shows the detailed credit ratings of
IBM from the three major agencies:
7
Credit Rating
Moody's
S&P
Fitch
Long-term
Aa3
AA-
A+
Short-term
P-1
A-1+
F1
The ratings reflects IBM
diversified revenue
base and leading and
defensible market
positions in a range of
information-technology
(IT) products, software,
and services. The
company has
demonstrated solid and
consistent earnings and
operating cash flow.
The ratings agency
lifted IBM's rating one
notch to "AA-" from
"A+" — both are
investment-grade
ratings.
Fitch's expectations for
stabilizing operating
trends, including the
resumption of positive
organic revenue
growth in the
intermediate term.
IBM's investments in
strategic imperatives
(data, cloud, and
engagement) should
drive double-digit
growth and achieve
sufficient scale in these
markets and begin to
offset long-term
secular decline in
legacy information
technology (IT)
demand (Reuters,
2015).
4. Stock Valuation
8
The stock value of IBM has significantly decreased from $189 in 2011 to $147 in
October 2015 (Yahoo Finance, 2015).
Dec-10
Dec-11
Dec-12
Dec-13
Dec-14
Latest
Qtr
Revenue %
Year over Year
4.29
7.06
-2.25
-4.55
-6.98
-13.92
3-Year Average
5-Year Average
0.36
1.85
1.05
3.18
2.96
1.13
-0.04
-0.76
-4.61
-0.63
—
—
10-Year Average
1.23
2.22
2.56
1.13
-0.37
—
Operating Income %
Year over Year
6.68
11.77
0.77
-8.15
-5.26
-19.35
3-Year Average
5-Year Average
10.33
14.12
8.37
11.19
6.31
8.63
1.14
3.33
-4.28
0.90
—
—
10-Year Average
4.55
8.12
11.64
6.41
4.95
—
Net Income %
Year over Year
10.49
6.89
4.72
-0.73
-27.06
—
3-Year Average
5-Year Average
12.50
13.33
8.73
10.81
7.34
9.77
3.58
5.97
-8.81
-2.18
—
—
10-Year Average
6.25
7.46
16.59
8.07
3.61
—
EPS %
Year over Year
3-Year Average
15.08
17.07
13.37
13.51
10.03
12.81
3.97
9.05
-20.35
-3.05
—
—
5-Year Average
18.79
16.41
14.89
10.84
3.52
—
10-Year Average
10.00
11.62
21.44
13.21
9.21
—
The core value drivers for IBM are:
•
The Service, Software, and Hardware revenue have been decreasing
continually; especially in Europe, Middle East, and Africa.
•
The five years average revenue percent has decreased from 1.85% to 0.63%.
•
The five years EPS average percent has decreased from 17.07% to 3.52%.
•
The mainframe era was coming to an end; IBM transforms itself from a
hardware manufacturer to a 21st century tech-services provider.
•
Business restructuring and product cycle transitions; some of the dramatic
changes IBM has undertaken lately include selling its commodity server
business to Lenovo, selling its semiconductor chip business to
GlobalFoundries, and divesting its System X business.
9
•
IBM has realigned its workforce as it continues to invest heavily in what it
terms as ‘‘Strategic Imperatives’’ (this consists of: Cloud Business, Business
Analytics, and Mobile Security).
•
IBM is one of several companies whose earnings have been severely impacted
by foreign exchange.
We reviewed IBM’s dividend over the past five years and calculated the average
growth rate over the last five years (which was approximately 14.2%). Presuming the
dividend growth rate stays the same forever, we used the One-stage DDM Model to
calculate the intrinsic stock value.
Annual Dividends
Dividend Amount
Year-end Yield %
12/2010
2.50
12/2011
2.90
12/2012
3.30
12/2013
3.70
12/2014
4.25
1.70
1.58
1.72
1.97
2.65
* Dividend Amount is calculated by using the ex-dividend rate
g
r
13.20%
14.20%
15.20%
15.60%
202.2460
346.7281
1213.9820
16.60%
142.7584
202.2460
346.7281
17.60%
110.3118
142.7584
202.2460
The DDM-1 model is equal to: D/(r-g) and the price of the stock should be as follows:
•
Present (2015)
•
Dividend (D0): 4.25
•
Dividend (D1) = 4.25*(1+14.2%) = 4.8535
•
Growth (g) = 14.2%
•
Average Dividend Yield = 2.405%
•
R= Average Dividend Yield + g = 16.5998%
•
Stock Value (P0) = 4.8535 / (r – g) = $201.81
•
Market Value = $160
Based on DDM model calculation, we conclude that IBM’s current stock price is
slightly under-valued.
10
IBM’s major competitors are Microsoft Corporation, Hewlett-Packard Company,
and Accenture plc. The following is a selected list of comparable companies for IBM.
Market Cap.
Employees
Qtrly Rev Growth (YOY)
Revenue (TTM)
Gross Margin (TTM)
IBM
136.40B
379,592
-0.14
83.80B
0.50
MSFT
426.99B
118,000
-0.12
90.76B
0.65
HPQ
49.40B
302,000
-0.08
106.05B
0.24
ACN
67.52B
358,000
0.01
31.05B
0.32
Industry
391.25M
2.02K
0.12
387.25M
0.27
EBITDA (TTM)
Operating Margin (TTM)
Net Income (TTM)
EPS (TTM)
P/E (TTM)
PEG (5 yr expected)
P/S (TTM)
21.66B
0.21
14.42B
14.37
9.78
1.30
1.63
32.44B
0.30
12.27B
1.50
35.54
2.14
4.75
12.76B
0.08
4.56B
2.44
11.24
10.83
0.47
5.15B
0.14
3.05B
4.76
22.61
2.10
2.21
24.60M
0.06
N/A
0.39
20.25
1.53
1.05
By comparing IBM with its major competitors, we have several findings:
Positives:
•
Margin is good
•
EBITAD is good
•
Operation margin is good
•
Net income is better
•
EPS is better
Negatives:
•
Quarterly revenue growth is negative
•
P/E is lower
•
PEG (Price/Earnings to Growth) is lower
Based on our analysis, the stock price should be between $160 and $200, which is
from the DDM model calculation. This is slightly higher than $140, which is the stock
price at the beginning of this year. But there are two factors which should not be
ignored: 1) DDM is based on the optimistic assumption; 2) investors would remain
hesitant about IBM Business restructuring and product cycle transitions.
11
5. IBM Capital Budgeting
IBM stated in its most recent conference call with analysts that the overarching
strategy for the expansion of its cloud platforms and offerings in big data is to get a
strong foothold in the emerging businesses of IT. IBM trusts that these investments
will prepare the company for better growth during the long term (The Motley Fool,
2014).
IBM Ventures into the Cloud
The “Blue giant” has been investing in cloud-based services as it branches out
away from hardware. This makes sense since hardware has been weighing on IBM for
some time; hardware has been the company's worst-performing segment since 2012.
IBM's revenue from technology and systems has deceased 16% through the first six
months, year over year. On the other hand, IBM has not experienced bad results in its
businesses except in the hardware. Cloud revenue has risen more than 50% during the
first half of 2014. Cloud-as-a-service revenue has increased more than double; a $2.8
billion annual run rate.
These results are the product of greater investment in the highly-growing
business. In the first quarter of 2014, IBM launched Bluemix, its cloud platform-as-aservice for the enterprise. IBM invested $1.2 billion to expand its SoftLayer cloud
hubs. IBM also invested $1 billion at that time to form the new Watson group, which
is to meet growing demand for cognitive innovations (The Motley Fool, 2014).
IBM made progress implementing these initiatives during the last quarter.
Bluemix became available in June, new SoftLayer data centers were opened, and IBM
divested its customer care business. Moreover, IBM will invest $3 billion during the
next five years in research and development in next-generation chips, which would be
integrated into cloud service and big data systems as important and fundamental parts
(The Motley Fool, 2014).
12
In the past ten years, IBM has experienced a transition away from hardware and
into other areas, such as software and services which are to improve profitability.
Hardware is a much lower-margin business than software and services. From 2000 to
2013, IBM's operating pre-tax margin had more than the doubled, from 10% to 21%,
which required a great deal of internal investment. IBM's capital expenditures have
totaled $59 billion since 2000. As a result of this, it makes sense for IBM to maximize
its investment in these areas. IBM has spent $13.9 billion on dividends and share
repurchases during the first half of the year; it spent $1.7 billion on capital
expenditures in the same period. Moreover, even if IBM didn't want to cut back on
dividends or share repurchases, it has $9.7 billion in cash sitting on the balance sheet
which it could draw from (The Motley Fool, 2014).
Net Present Value (NPV) has been considered in our analysis. The benefit of
NPV is that it takes into consideration the time value of money and adjusts all cash
flow into today’s price to show its intrinsic value. Since there isn’t any available
public information of IBM’s projects, there is not a specific calculation here.
However, we learned the company’s NPV is heavily dependent on reliability.
Therefore, we assumed two projects (Project A and Project B) to illustrate IBM’s
NPV:
Based on the above analytics, management would choose Project A because of the
higher NPV.
13
The second capital budgeting technique is the Internal Rate of Return (IRR). The
higher the IRR is, the better the decision is (support) to make the capital investment.
By using the same example for the NPV, the first project has an IRR of 16.32%
compared to the WACC requirement of 9%. Project A would be selected over the
second project (Project B) which has an IRR of 5.91% (and would not meet the
minimum rate of 9.5%), thus Project B would be rejected.
The third capital budgeting technique is the payback period. Based on our
calculations, the payback period is 4.0 periods. Also, we included the discounted cash
flow payback period which uses the concept of time value of money. The discounted
payback period is 5.6 periods.
The stock price of IBM has decreased during the past three years which may be
perceived as the company’s value having deteriorated. Meanwhile, during the same
period, IBM’s revenue%, operation income%, net income% and EPS%, which are
significant indicators of a company’s value, have decreased. Therefore, we have to
admit that IBM’s value has worsened during this time.
14
6. IBM’s Cost of Capital and Capital Structure
Cost of Debt
Cost of debt is the effective rate that a company pays on its current debt. IBM’s
weighted cost of debt is as follows:
1
09/14/2017
3000.000
8.6%
1.25
Weighted Average
Cost of Debt
0.106916
2
3
4
5
6
7
8
9
10
11
12
13
02/12/2024
07/22/2016
11/06/2020
10/15/2018
02/06/2018
08/01/2023
05/15/2020
12/21/2020
11/07/2025
05/26/2023
11/19/2019
06/20/2042
2000.000
2000.000
1694.000
1600.000
1500.000
1500.000
1250.000
1154.200
1129.300
1129.300
1129.300
1107.300
5.7%
5.7%
4.8%
4.6%
4.3%
4.3%
3.6%
3.3%
3.2%
3.2%
3.2%
3.2%
3.21
0.00
2.09
2.20
1.31
3.13
2.09
2.09
3.45
3.13
1.80
4.45
0.183040
0.000000
0.100942
0.100358
0.056024
0.133858
0.074485
0.068776
0.111081
0.100778
0.057955
0.140487
14
15
16
17
18
19
20
21
22
23
24
25
11/06/2021
01/05/2016
02/05/2016
02/08/2018
08/01/2022
05/06/2016
02/06/2017
02/12/2019
02/12/2019
11/01/2019
11/30/2039
11/29/2032
1100.000
1000.000
1000.000
1000.000
1000.000
1000.000
1000.000
750.000
750.000
750.000
745.100
600.000
3.1%
2.9%
2.9%
2.9%
2.9%
2.9%
2.9%
2.1%
2.1%
2.1%
2.1%
1.7%
2.43
0.31
0.31
1.34
2.70
0.77
0.85
1.80
1.92
1.70
4.50
4.11
0.076210
0.0088380
0.0088380
0.0382050
0.0769790
0.0219530
0.0242340
0.0384900
0.0410560
0.0363510
0.0955950
0.0703080
26
27
28
29
30
31
32
33
34
10/30/2025
05/15/2019
11/01/2021
02/06/2018
08/01/2027
08/05/2022
02/10/2017
12/01/2096
01/15/2028
600.000
600.000
500.000
500.000
468.600
461.700
377.100
336.400
313.000
1.7%
1.7%
1.4%
1.4%
1.3%
1.3%
1.1%
1.0%
0.9%
3.45
1.84
2.43
1.34
3.81
2.70
1.44
5.22
3.66
0.0590170
0.0314760
0.0346410
0.0191020
0.0509020
0.0355410
0.0154820
0.0500650
0.0326610
No.
Time
Amount $
% of TD
YTM%
15
35
36
10/30/2045
10/15/2038
27.000
2.062
0.1%
0.0%
35074.362
1
4.62
4.48
0.0035560
0.0002630
2.1044650
IBM’s cost of debt is 2.10%. Due to IBM’s standing as a dominant and fast
expanding industry leader, the comparison of its cost of debt among competitors is not
quite meaningful.
Cost of Equity
𝐶𝑜𝑠𝑡 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 = 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑌𝑖𝑒𝑙𝑑 + 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐺𝑎𝑖𝑛 𝑌𝑖𝑒𝑙𝑑
The cost of equity measures the stockholders required rate of returns on their
investments. Dividend yield is 2.65%, and capital gain yield is 14.19%. Thus, the cost
of equity is 16.84%.
WACC
Weighted Average Cost of Capital (WACC) is a calculation of the company’s cost
of capital in which each category of capital (debt, preferred stock, and common stock)
is proportionately weighted.
WACC
Debt
Preferred Stock
Equity
WACC
Weight of Total
Capital
74.17%
2.10%
Weighted Average
Rate
1.57%
0.00%
0.00%
0.00%
25.28%
16.84%
4.26%
RRR
5.83%
The optimal capital structure is determined as the capital structure for which the
company’s WACC is the lowest; the lower the WACC, the higher the value of the
company. Since the optimal capital structure is a hypothetical assumption, anyone
could assume what the business would need to generate enough cash flow to cover
interest payments. However, we think it is prudent to include the payment of principal
16
as well, since “real world” lenders require the repayment of principal, and rolling over
the debt continually may not always be an option.
Therefore, reasonable terms for debt repayment should be assumed, and an
amortization schedule should be generated for this analysis. If the possibility analysis
shows the cash flows of the company cannot support the optimal capital structure
indicated, the evaluator should reduce the level of debt in the analysis until the
coverage ratios and rates of return to equity are reasonable for investors. In short,
comparing with the industry standard 6.95%, it is optimal capital structure.
EVA
Economic Value Added (EVA) is a measure of a company's financial performance
based on the residual wealth calculated by deducting the cost of capital from its
operating profit.
𝐸𝑉𝐴 = 𝑁𝑒𝑡 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑃𝑟𝑜𝑓𝑖𝑡 𝐴𝑓𝑡𝑒𝑟 𝑇𝑎𝑥𝑒𝑠 (𝑁𝑂𝑃𝐴𝑇) − (𝐶𝑎𝑝𝑖𝑡𝑎𝑙 × 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐶𝑎𝑝𝑖𝑡𝑎𝑙)
Year 2014
$ (Millions)
EBIT
20,470
Tax
4,234
NOPAT
WACC*Capital
EVA
16,236
2,735
13,501
Companies with high EVA should over time outperform others with lower or
negative EVAs. However, the actual EVA level matters less than the change in the
level. According to research conducted by Stern Stewart, EVA is a critical driver of a
company's stock performance. If EVA is positive but is expected to become less
positive, it is not giving a very good signal. Conversely, if a company suffers negative
EVA but is expected to rise into a positive territory, a good buying signal is given
(Ben McClure, 2015).
17
7. Conclusion
The purpose of this paper is to analyze IBM’s performance in its industry to reach
a decision regarding whether to buy, sell, or hold IBM’s stock. Therefore, the
comparison of IBM and its industry average would be needed to have a good idea
about IBM performance in the market. IBM’s beta is 0.59 while the industry’s beta is
0.84. In addition, the ROE for IBM is 100% and 22.24% for the industry. IBM’s cost
of equity is 16.84%, however, the industry’s cost of equity is 7.26%. Also, IBM’s cost
of debt is 2.10% although the industry’s cost of debt is 5.04%. IBM’s EVA is
$13,501.00 and the industry’s EVA is $19,011.80. Finally, IBM’s cost of capital is
5.83% but the industry’s cost of capital is 6.96%.
IBM has been heavily involved with Artificial Intelligence (AI) as is iconically
remembered from 1996 when “Deep Blue” took on World Chess Grandmaster Gary
Kasparov. The company’s continued focus in investing in big data analytics and its
“Strategic Imperatives” is most definitely vital for its continued growth and success
that will reap benefits for the company as it redefines its core business in the 21st
century. This is obviously a move in the right direction as seen by Warren Buffet’s
(and Berkshire Hathaway’s) continued purchasing of IBM stock since 2011 wherein
Berkshire Hathaway had acquired a 5.5% stake in the company to its current 8.3%
stake of the company that is presently valued at $12.3B. The potential long-term
reward is arguably worth the current risk (Housel, 2015).
Based on the above data and our analysis, coupled with IBM’s historical business
sensitivities, we recommend investors to consider holding their IBM stock (for the
short term) and buying IBM stock (for the long term) because of the following
reasons:
•
Under-valued stock price
•
Positive free cash flow
•
Normal dividend yield is 3%
18
•
Short average maturity of debt is 8 years
•
EPS is better
•
Quarterly Revenue Growth is negative
•
P/E is lower
•
PEG (Price/Earnings To Growth ) is lower
Recommendations
From the financial standpoint, IBM is good since it tries to do what it can do to
keep good WACC, good EVA, and other financial measures. From the business point
of view, the mainframe era is coming to an end; IBM must transform itself from a
hardware manufacturer to a 21st century tech-services provider. Although IBM has
realigned its workforce as it continues to make huge investments in its ‘‘Strategic
Imperatives’’, investors may remain hesitant about IBM Business restructuring and
product cycle transitions. It is impertaive for IBM to find strong revenue growing
parts and complete its restructuring soon.
19
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IBM. (2015). Company Profile. Retrieved from:
www.reuters.com/finance/stocks/companyProfile?symbol=IBM.N
McClure, B. (n.d.). All About EVA. Retrieved from:
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