It has been 6-years of dead money and revenue declines, but International Business Machines Corp (NYSE:IBM) finally seems to have its act together. As a result, 2017 will likely be a good year for IBM stock because of the moves that management is making today, and has made over the last year.
My biggest issue with IBM over the last few years has been its spending relative to FCF. At this time two years ago IBM had spent $18 billion on buybacks and another $4 billion on dividends. The $22 billion far exceeded its $13 billion in free cash flow.
For quite some time IBM’s FCF kept declining, yet its dividend and buybacks kept rising, thereby illustrating that IBM was spending more money than it made. In no business is this a formula for success.
With that said, IBM is paying for bad investments and aggressive spending, with only $10 billion in cash; $42.5 billion in debt; and a debt-to-asset ratio that has consistently risen. However, the company has become more responsible over the last year. Not only has 12-month free cash flow risen to $14.5 billion, but combined dividends and buybacks are less than $8.5 billion. That’s a proper ratio for a mature business that still plans (and needs) to spend on business investments.
IBM stock looks like a good investment
There is no question that IBM has been the biggest loser due to innovation and change in the IT space. Back in 2013 Barclays noted that cloud migration is destroying on-premise IT. The analyst, Ben Reitzes, believed that each dollar spent in the cloud took multiple dollars from on-premise IT; the cloud is more effective than traditional or existing business functions. Hedge fund manager Stanley Druckenmiller shared that sentiment by calling IBM a “great short”.
While IBM has developed and acquired its own cloud business, there’s no question the $20 billion lost in annual revenue is a direct correlation to the rise of AWS and others alike. Yet, three years later, IBM is expected to produce revenue without losses in 2017, and has grown its cloud-as-a-service business to $7.5 billion with 66% growth.
Therefore, at 12x forward earnings with a 3.3% yield, IBM stock is not a bad choice for dividend investors. Fact is the company has turned around most of the bad habits that made IBM stock such a horrible investment in years past. With more responsible spending, there’s a great chance that dividend investors will flock to IBM stock over the next year.