IBM's day of reckoning is near
Thomson Reuters
I got a lot of positive feedback on my recent column, “Anatomy of a Successful Short Sale.” It’s no surprise, though. Spotting failing companies is as useful and lucrative as uncovering hidden gems.
Now let’s put theory into practice and take a look at a stock that my subscribers are currently shorting.
That stock is IBM.
IBM recently reported its quarterly results. The see-no-evil analysts on Wall Street jumped for joy at what I think were terrible results.
What was so terrible? Here are the reasons why I expect this stock to fall.
Acquisitions to hide falling revenues
How about this: IBM has reported falling revenues for 17 consecutive quarters.
Thomson Reuters
IBM pulled in sales of $20.2 billion last quarter. But that’s 2.7% less than a year ago and 25% lower than in 2011.
Thomson Reuters
The weakness is widespread:
- Global Business Services had revenues of $4.3 billion, down 2%.
- Technology Services & Cloud Platforms (includes infrastructure services, technical support services, and integration software) had sales of $8.9 billion, down 0.5%.
- Systems (includes systems hardware and operating systems software) had sales of $2 billion, down 23.2%.
- Global Financing (includes financing and used equipment sales) had sales of $424 million, down 11.3%.
- With all that red ink, acquisitions are the only way you can make yourself look good. IBM has bought 11 companies worth $5 billion so far this year.
In fact, it has spent more on acquisitions in the last 12 months than ever before.
The acquisitions have boosted the Q2 revenues of $20.2 billion by $400 million. So, the results would have been even uglier without them—a 5% decline instead of the current 2.7% growth.
Pro forma calculations and massaged profits
IBM reports its earnings on a pro forma basis instead of a GAAP basis (I wrote about this tactic in detail in this column). This way it can use “accounting magic” to prop up its pro forma profits.
IBM reported better-than-expected “pro forma” profits of $2.95, which was above the average forecast of $2.88. On a GAAP basis, those profits shrink to $2.61 a share.
Thomson Reuters
Still, even those phony pro forma calculations are 25% lower than a year ago.
A cash hoard of borrowed money
IBM is proud of its cash hoard, which increased from $7.6 billion in Q2 of 2015 to $10.6 billion today. That cash, however, didn’t come from operating profits. It’s borrowed.
IBM had $33 billion of debt a year ago. The company took on $11.5 billion more and now owes a staggering $44.5 billion.
Thomson Reuters
That $10.6 billion cash isn’t going to last long. IBM is burning through it. The company had $3.4 billion of operating cash flow in Q2 but spent $5.9 billion on:
- $1.0 billion on capital expenditures
- $2.8 billion on acquisitions
- $1.3 billion on dividends
- $800 million on share repurchases
That’s $2.5 million of negative operating cash flow. Only IBM’s debt makes it possible. It’s a big warning sign of a company in trouble.
By the way, competitor Infosys warned that Brexit could hurt its business. IBM, however, adopted the see-no-evil defense: “Brexit didn’t help, but from everything we’ve seen we haven’t changed our view,” said CFO Martin Schroeter.
I think that IBM’s day of reckoning is near…
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