Why We Revised Our IBM Price Estimate To $179

by Trefis Team
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We recently revised our price estimate for IBM’s (NYSE:IBM) stock from $144 to $179, a 24% increase from our earlier estimate. Over the past few years, IBM has transformed its business from a hardware-centric and perpetual license software vendor to a cloud solutions service provider that is effectively employing Artificial Intelligence (AI) and machine learning. As a result of this transformation, some of the risks associated with the company have been mitigated. Below we highlight some of the changes we made to our model and some factors that led to those changes.

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Cognitive Solutions Software To Boost Software Revenues 

IBM’s Cognitive Solutions segment includes Solutions Software (roughly two-thirds of the business) and Transaction Processing Software. The segment includes many of the company’s strategic areas, including analytics, e-commerce, and security, as well as several of the new initiatives around Watson, Watson Health, and Watson Internet of Things.

IBM has established one of the world’s deepest portfolios of data and analytics solutions. These solutions include analytics and data management platforms, cloud data services, enterprise social software, talent management solutions, and most of these solutions can be tailored to an industry. These solutions have helped the company post growth in revenues. Furthermore, due to the nature of this business, these revenue streams are stable and have massive growth potential going forward. As the company is in the middle of developing some of these capabilities, it has expended significant R&D resources on them, which has put some pressure on its EBITDA margins (which contracted to 35% in 2016). While we currently project margins for the company to increase to 36% by the end of our forecast period, a significant upside can be expected if margins were to rebound to over 40% by 2023.

 

Infrastructure & Cloud Services To Boost Technology Services Division

One of the key changes IBM has made to its business is a shift away from technology outsourcing to Infrastructure and cloud services, which are higher up in the value chain and have sticky revenue streams. IBM’s portfolio includes a comprehensive set of hybrid cloud solutions and services that allow clients to develop and run enterprise applications on both public and private clouds. Furthermore, IBM’s Cloud Infrastructure-as-a-Service (IaaS) covers a wide variety of workloads with solutions encompassing cognitive computing and hybrid cloud implementation.

These services should help the company generate a stable revenue stream, reducing the fluctuation in revenues that originated from renewal or non-renewal of contracts. While we currently project revenues for this division to decline slightly over our forecast period due to a shift away from traditional outsourcing, the margins for new infrastructure and cloud services are significantly higher. In 2016, the EBITDA margins for this business were at 25.2%, 200 basis points better than the traditional outsourcing business, according to our estimates. We conservatively estimate that margins will improve to 25.5% by the end of our forecast period. However, if margins were to improve to 30%, there can be a 10% upside to our price estimate.

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