Merry Christmas!
https://www.barrons.com/articles/ibms-debt-and-deal-make-stock-a-big-loser-again-51545652800
Big Blue’s shareholders are getting used to seeing red.
International Business Machine (IBM) stock has posted the third biggest decline in the Dow Jones Industrial Average this year, down 28% as of Dec. 21. Last year it was the second-worst performer, behind only General Electric (GE).
IBM stock underperformance has been driven by concerns about the outlook for a key software business, and skepticism about a debt-financed megadeal for software provider Red Hat (RHT).
The year got off to a good start for the tech giant, as it strung together three consecutive quarters of revenue growth. Its shares were slightly higher for the year before a broad market selloff hit its shares in early October.
But its fortunes took a turn on October 17, when IBM reported that third-quarter revenue fell from the prior year. Shares fell 8% on the news.
Investors keyed in on weaker-than-expected revenue in a key software business. While that business—called “Cognitive Solutions”—is only responsible for about 25% of IBM’s revenue, management was targeting faster sales growth in that line than the company’s other businesses. The Cognitive Solutions segment includes IBM’s “Watson” artificial intelligence software, and its business processing transactions for companies in the banking, airlines and retail sectors.
About two weeks after its third-quarter report, IBM announced a $34 billion deal to buy Red Hat to expand its cloud computing business. The expansion will be pricey: Its purchase price valued Red Hat shares at a 63% premium to where it was trading at the time, and 55 times this year’s expected earnings. And it will face strong competition from players like Amazon.com’s (AMZN) Amazon Web Services, which serves about half of the market.
That deal will be financed by cash, which really means debt. The company could add $25 billion of debt to its balance sheet, according to CreditSights. Two major credit ratings firms have downgraded IBM’s credit to A from A+, and the third has its rating under review.
Highly indebted companies have come under pressure in the fourth quarter of 2018, in part because the Federal Reserve has raised rates four times. Credit spreads have widened as well, which means investors want more compensation for the risk that companies will default.
IBM says it will halt share buybacks to reduce leverage from the deal. But it won’t do that until 2020. And after nearly a decade of economic expansion, many investors and strategists are on recession watch. So next year, the tech giant will be racing the clock to integrate Red Hat and reduce its debt.
Or IBM stockholders could be seeing red again.