Shares of Narrow-Moat IBM Look Overvalued

IBM IBM broke its streak of five quarters of year-over-year revenue declines in reporting its fourth-quarter results, but we don’t see this as a harbinger of a turnaround. Rather, the revenue increase was largely a result of the start of another mainframe cycle (which last typically five quarters). Still, fourth-quarter revenue was slightly below our expectations though EPS was in line with our forecasts--with help from profitability improvements. Considering the lumpiness caused by mainframe sales and expectations for 2020, we are maintaining our $128 fair value estimate for this narrow-moat-rated name.

IBM reported fourth-quarter revenue of $21.8 billion, up 10 basis points year over year, closing the year with $77.1 billion in revenue, a 3.1% decrease year over year. While the systems segment made up only 14% of revenue, systems sales in the quarter were up 16% sequentially, marking the first full quarter after the z15 mainframe release. Meanwhile, global technology services, or GTS, was down nearly 5% year over year in the quarter, which we expect was largely due to non-mission-critical workloads transferring to competitor clouds for infrastructure management. The cloud and cognitive segment reported revenue growth up 9% year over year for the fourth quarter, with growth across all areas, including transaction processing platforms--which we consider to be one of the most mission-critical IBM offerings. Consulting revenue saw a lift of 4% year-over-year growth in the quarter, but that did not overcompensate for global business services’, or GBS', roughly flattish revenue growth in the quarter, which is suffering weak demand for business process outsourcing. We’re encouraged that the consulting business is not suffering instead, as consulting is a much higher-margin business, and we consider it to be a driver of other IBM offerings. Moreover, we expect business process outsourcing revenue to decline throughout the IT services industry.

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