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Commentary

Wait for a Wider Margin of Safety on IBM

While IBM remains in an enviable position, long-term risks remain, and we don’t see a buying opportunity today.

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 IBM's (IBM) full-year results came in slightly ahead of our expectations, but the company provided a disappointing outlook for fiscal year 2016 as it attempts to successfully transition away from declining legacy business lines. For fiscal 2016, IBM expects operating EPS to be $13.50, which reflects an approximate 7.5% negative foreign exchange impact and continued drag from mature lines of business. The firm’s multiyear transformation toward Strategic Imperatives remains a small but positive highlight. Strategic Imperatives, which include analytics, cloud, mobile, security, and social, grew 26% year over year to $29 billion and constitutes 35% of the company’s revenue (up from 22% in fiscal 2013). IBM’s growth potential in these high growth markets is expected to help alleviate structural declines in its core business. However, a successful transition is far from certain. We are maintaining our wide moat rating, but we expect to lower our fair value estimate by approximately 15%.

For the year, revenue from continuing operations fell 12% year over year to $81.7 billion (declining 1% in constant currency). The analytics and cloud businesses were solid performers growing 16% and 57% during the year, respectively, but outsourcing and consulting and systems integration sales remained weak given intense competition. For the time being, we think IBM’s management team will have to manage its difficult core operating environment, foreign exchange headwinds, spending cycles, elevated investments levels, and transactional software spending – not an easy task. While IBM remains in an enviable position, long-term risks remain. Although the shares are likely to be trading at a discount to our fair value estimate, we would caution investors to seek a wider margin of safety before committing capital to the name.

Rick Summer does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.