International Business Machines Corp. (IBM): The Writing Is on the Cloud, my Dear Watson

International Business Machines Corp. (NYSE:IBM) has a long track record of being on the cutting edge of technology shifts, and today is no exception.  Last week, IBM’s CEO addressed the three eras of computing as Tabulating, Programmable and Cognitive.   In 2011 IBM developed a computer program that can understand human language so well that it beat two of the greatest Jeopardy! players of all time.  IBM is just starting to monetize Watson by bringing him to market in the health care and financial services industries.  The implementation of Watson has the capability of streamlining processes that involve massive amounts of unstructured data, like reviewing electronic medical records.  Opportunities like this will be very valuable to IBM’s clients in the medical field that currently rely on skilled nurses to review these records, who could otherwise be helping treat patients.

The Top 4 Tech Stocks to Own in 2013Watson will help IBM solidify a position in the cloud. Cloud computing is one of IBM’s stated growth initiatives.  By having large databases in the cloud for their clients, IBM can cross-sell their Watson technology to help businesses make sense of their “Big Data.”  IBM will do this by turning these data points into action in a host of different industries from Rail, to Financial Services, to Health Care. By being at the forefront of the “unstructured” data revolution IBM puts itself ahead of its competitors and helps IBM build out its moat as a first mover.

Valuation and Competitors

IBM has completed its 2010 roadmap of increasing EPS over $10, with room to spare, and is now on track to beat the $20 EPS they have targeted for 2015.  Between IBM moving into larger margin businesses and their aggressive share buybacks, IBM looks cheap on a PE basis right now.  Currently IBM is trading at a 14 P/E ratio while Oracle Corporation (NASDAQ:ORCL) is trading at 16.5 and SAP AG (NYSE:SAP) is trading at 25.  If IBM is earning $20 per share by 2015 at its current conservative P/E ratio, it will be a $280 stock.  That is a 40% increase from today’s price for a blue chip company without any expansion in its P/E ratio!

The whole big data industry is taking off right now.  Oracle’s cloud services revenue have increased 18% in the past quarter alone.  SAP has broken into the Cloud market in a big way since entering in 2011.  According to their annual report they went from cloud services revenue of $20 million to over $270 million, a 1400% increase. IBM is using its developed network of sales representatives as well as its long standing relationship with clients to defend its moat against these two competitors.  IBM has been in the cloud space since 2005, and from 2011 to 2012 has increased its revenue from cloud services 80%. As these software titans battle for their business, IBM has an advantage of selling a complete in-house IT system for corporations, from the mainframe and servers to software.  This gives IBM an edge as its customers only have one point of contact for their IT solutions.  This is part of the reason that in 2012 IBM had over $400 million in competitive replacements of sales services contracts from competitors like SAP and Oracle.

Investors

IBM is a large scale first mover of the cognitive computing revolution and is trading cheaply on a P/E ratio basis to its peers.  Warren Buffett’s Berkshire Hathaway Inc. (NYSE:BRK.B) has invested $10.7 billion in IBM back in 2011 purchasing 64 million shares, and has added another 2.6 million since, for a total of 66.6 million shares worth over $13 billion today.  Not only does Buffet own more shares than he did in 2011, since IBM has repurchased nearly 100 million shares, Buffett’s ownership stake has gone from 5.2% at the beginning of 2011 to 5.9% at the end of 2012.

The Foolish Bottom Line

Given the trajectory of IBM in the Big Data movement and its financial discipline in repurchasing shares, it’s not hard to see why CFO Mark Loughridge set a target to double IBM’s earnings per share in 5 years. IBM has a stated mission of becoming “the worlds most essential company,” and they plan on digging their moat with Big Data.

The article The Writing Is on the Cloud, my Dear Watson originally appeared on Fool.com and is written by Wes Patoka.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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