Brian White Comments: Five Charts Show Why IBM Is Worst Dow Performer for Second Year

January 5, 2015, Bloomberg News

For the second year in a row, IBM is on track to be the worst-performing stock in the Dow Jones Industrial Average.

Since Ginni Rometty became chief executive officer in January of 2012, the shares have fallen 16 percent — 14 percent of that this year alone. Investors have dumped the stock as Rometty struggles to re-imagine International Business Machines Corp. as a contender in cloud computing, data analytics and mobile technology. So far, those new areas haven’t made up for a decline in sales of legacy hardware and technology consulting services.

The following five charts show that Rometty will struggle to turn IBM around because the company is generating less free cash flow than before, underspending peers on research and development and boosting debt to help pay for dividends and share buybacks.

“IBM is rapidly transforming, shifting to new opportunities,” said James Sciales, a spokesman for IBM. “Throughout 2014, the company has been laser focused on this new path.”

Yet though the company says its cloud strategy is making progress, the knock on Rometty is that IBM waited too long to move into this business and is now playing catch-up with Inc. and Microsoft Corp. Next month, Rometty, 57, will get her chance to update investors on her plans for 2015.


IBM shares haven’t been this cheap relative to free cash flow in more than three years, indicating investors anticipate slower growth. Free cash flow is the money a company generates after paying to maintain its assets and current growth. When companies generate less cash, they have less money to invest in new businesses, dividends and share buybacks.

IBM’s price to free cash flow ratio fell to as low as 11.6 this month, lower than 85 percent of companies in the Standard & Poor’s 500 Index. The low ratio shows investors are increasingly skeptical of IBM’s ability to generate cash the way it once did.

In October, Big Blue reduced its forecast for free cash flow to $12 billion to $13 billion this year, down from a projection for $16 billion only a quarter earlier.


In 2013, IBM paid out about $4.06 billion in dividends to shareholders and spent $3.62 billion on its physical assets, like building the data centers required to expand its cloud business. It was the first time dividends outpaced capital spending, according to data compiled by Bloomberg that dates back to 1987. Analysts say the trend likely continued in 2014.

IBM also spent more than $19 billion buying back shares in the last four reported quarters, the equivalent of about a fifth of total sales. The buybacks reduced the number of shares outstanding to the lowest since at least 1999, which in turn made earnings per share higher and helped IBM get closer to its profit targets.

Chief Financial Officer Martin Schroeter has defended the strategy, saying IBM reinvests in the business as well as returning funds to shareholders. “It is a false choice to think we do one or the other,” he wrote in a Dec. 4 commentary on


New borrowings have helped fund dividends and buybacks. IBM’s net debt — its total debt minus cash — has risen by more than $10 billion in the past year to $36.1 billion, the most since at least 1980.

That figure includes the company’s financing business. Excluding that business, IBM said in a regulatory filing last month that it expects to end 2014 with “core” debt that is “fairly consistent” with 2013, when it reported core debt of $12.2 billion.

The company still has A-level, investment-grade credit ratings, giving it plenty of access to additional funding as needed.


IBM spends about $6 billion a year on research and development, which has led to offerings like its Watson data-analytics supercomputer and has helped it churn out more patents than any other company for 21 straight years.

Even so, IBM is spending only about 6 percent of its annual revenue on research and development — an investment that’s crucial for tech companies to develop the next wave of innovative wwwucts. That’s half the average that its S&P 500 Index information technology peers are spending. Competitors like Google Inc., Cisco Systems Inc. and Oracle Corp. typically spend about 13 percent.

“Ultimately, the R&D underinvestment may be one of the fundamental flaws of the recent EPS roadmap and weakened the company’s positioning over the long term,” Kulbinder Garcha, an analyst at Credit Suisse Group AG, wrote in a Nov. 17 note.


To bolster gross margins, Rometty has been divesting money-losing businesses that in 2014 alone had pretax losses of about $500 million. IBM says the move frees up money than can be invested in its transformation.

However, the divestitures cost IBM about $7 billion in annual revenue — or about 7 percent of total sales. Meanwhile, investments in data analytics and mobile applications, such as a partnership with Apple Inc., have yet to generate meaningful revenue or make up for slowing profit growth.

Bottom line: The pressure is on Rometty to improve Big Blue’s performance, or risk attracting the attention of an activist investor, Brian White, an analyst at Cantor Fitzgerald, wrote in a Dec. 4 note.

“Change is in the air in 2015,” White said