IBM: A Legacy Worth Owning

It is beyond doubt that the last decade has seen frequent reversals in positions in the tech sector with a few of the big names like Microsoft (MSFT), Cisco (CSCO) and IBM (IBM) facing rough times and going down as legacy leaders of the domain. In recent days, IBM shareholders were disappointed and concerned after the Chinese government issued a call to Chinese corporations, especially major banks, to replace American hardware with locally manufactured servers and other components due to spying allegations.

Tryst with China

However, this political dispute over spying allegations has not deterred Chinese companies from using International Business Machines Corporation for their server needs. This new phase of anti-American edict stems from the U.S. Department of Justice which filed charges of hacking activities against five Chinese military officers. The People's Liberation Army officers allegedly engaged in cyber espionage against American companies.

The Chinese government retaliated by releasing a report condemning America's cyber warfare activities. This discontent clearly highlights the intent of Chinese authorities to minimize the involvement of U.S. firms in their massive IT markets and this may not be such good news for IBM as it is an important market for the company. Twenty-three percent of IBM's revenue came from the Asia-Pacific division in 2013, down from 25% in 2012. Chinese sales have fallen more than 20% year over year in each of the last three quarters. As of now, a majority of Chinese corporations are sticking to IBM servers because of their stellar performance, but investors need to be cautious of the brewing anger within the Chinese authorities and its impact on IBM's operations.

Cloud Is the Way to Go

While the Chinese story and turn of events may not be under much control of the company, the cloud services are under its complete control, and the company is sure taking a few favorable steps in that direction. Yes, I am talking about its platform-as-a-service product Bluemix.

IBM is beefing up its Bluemix platform-as-a-service, ushering in decades of software development expertise in an attempt to muscle into this developer-oriented form of cloud computing. If it can attract more developers to its SoftLayer unit, then it's likely to find more enterprise applications deployed on that same platform.

Bluemix is a set of tools, languages, application services, and "Boilerplates" on top of an IBM-specific version of Cloud Foundry that runs on SoftLayer infrastructure. Cloud Foundry is open source PaaS, launched by VMware spin-off Pivotal, and now independently governed by its own foundation. It runs on Amazon Web Services, but there is a downloadable version that IBM has installed on its own SoftLayer cloud unit. Read more about it here.

Performance on the Exchange

Over the last year, this IT colossus saw considerable volatility on the exchange with the price falling from $200 levels to the current $180 range and while there were different triggers for this volatility, one of the main reasons was slowing servers business wherein the revenue kept declining through the last year. However, after many rounds of negotiations, IBM was finally able to shed off the baggage and sold its x86 server business to Lenovo for $2.3 billion. The move will bring a better focus on cloud and security businesses, the burgeoning growth areas.

A Word on Valuation

A noticeable debate that has existed among analysts for quite some time now is regarding the valuation of the stock. Before I make my comments on the valuation of IBM, here are some numbers to give you insight into the value of the company. According to Alpha Omega Mathematica, IBM's forward P/E of 9.39 is far below its industry peers' average of 16.02. The low forward P/E has sustained in spite of IBM giving a high dividend yield of around 2.36, which resulted after a hike of 15.8% in the dividend in second quarter 2014. Besides a huge dividend, the company also returned cash to its shareholders by making share repurchases to the tune of $8 billion over the quarter. In fact, as a consequence of these share repurchases, IBM has reduced its outstanding shares considerably and pumped up its EPS over the last quarters.

In conclusion though, it is fairly clear that IBM is still under-priced as compared to its peers, and this price is a good entry point considering the lucrative growth opportunities lined up for the company in the future.

Final Words

IBM is a legacy company and though it does not enjoy the massive standing that existed approximately a decade ago, the company is attempting to revive its operations. I am highly optimistic about the effects of growth of IBM's server business sale along with its growing presence across cloud and security solutions. All in all, it is an attractive stock at a reasonable price.

About the author:Riddhi KharkiaA practicing Chartered Accountant based out of India. I have keen interest in analyzing tech stocks that are driven by value.

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