Barron's Take
IBM Could Struggle in the Cloud, Analyst Says — and Watch Out for Activist Investors
IBM could have “little to no growth” in earnings over the next three years—and an activist investor could intervene and shake things up, one analyst says.
MoffettNathanson predicts that IBM (ticker: IBM) will have “little to no growth” in earnings over the next three years—and that an activist investor could intervene and shake things up.
The back story. IBM is buying software firmRed Hat (RHT) to extend its reach in the fast-growing cloud. The move comes at a fraught time for the company’s legacy hardware business; sales of its servers are slowing after a wave of companies upgraded their hardware last year.
IBM is paying up for Red Hat. At the time of the deal announcement, IBM’s $34 billion offer was a 63% premium to Red Hat’s share price. But Big Blue has gotten a hand from low bond yields, after the Federal Reserve decided to pause its rate increases for most of this year. About 41% of the $20 billion in bonds it sold on Wednesday to finance the Red Hat purchase mature in 10 to 30 years, which means it has locked in coupons between 3.5% and 4.4% for decades.
What's new. MoffettNathanson analyst Lisa Ellis isn’t convinced the Red Hat deal will be a success. In a Thursday note, she outlined the reasons IBM is her top sell in the corner of tech she covers (IT processing and services).
While the move into the cloud is the right one for IBM, she says, it isn’t enough to generate growth. The analyst thinks the acquisition will boost revenue by less than 1 percentage point. And IBM’s ability to achieve its cloud ambitions may be limited by its focus on the so-called hybrid cloud, or corporate tech that operates partly with on-site servers and partly in the cloud.
Its cloud offerings also “trail competitors” such as Microsoft’s (MSFT) Azure, she said, and while “Red Hat’s products may help address this problem...it may not be enough.”
Looking ahead. Ellis is forecasting a compound annual growth rate of just 0.6% in the company’s earnings per share over the next three years.
In IBM’s fourth-quarter earnings report, the company forecast 0.7% growth in earnings per share this year, which was higher than Wall Street had expected.
And that isn’t all. She also wrote that an activist investor may try to step in and lobby for changes at the company this year. That prediction was essentially in a footnote of the note, however, so Ellis didn’t elaborate much on which investor would step in, or what specific changes they would want. But she did say that it could happen before the Red Hat acquisition closes, which the company expects to occur in the second half of this year.
Write to Alexandra Scaggs at alexandra.scaggs@barrons.com