Growth at the End of the Tunnel for IBM

Management did sidestep the issue of revenue growth for the business in fiscal 2017, instead focusing on the pretax income margin expansion story. However, on a full-year basis, we still think fiscal 2018 will be the year when strategic imperatives revenue growth finally outweighs core revenue declines. To that end, we think IBM remains highly relevant in the analytics, cloud, mobile, and security fields, which are expected to fuel multiyear strategic imperative revenue growth.

After rolling our financial model forward one year and making some long-term adjustments to our tax rate based on management commentary, we raise our fair value estimate for IBM to $158 from $145 and maintain our narrow economic moat rating. We believe the firm is trading slightly above its intrinsic value and would suggest investors seek a wider margin of safety before committing capital to the name.

For the year, reported revenue fell 2% year over year to $79.9 billion. Analytics (up 9%), cloud (up 35%), and mobile (up 35%) were the primary areas of yearly growth, and we expect these businesses to continue similar growth in the near term as clients leverage these newer digital technologies. On the margin front, IBM’s gross margin and pretax income margin both fell, as the company had higher levels of investments and acquisitions in the year. However, the firm has indicated that it has finished with its accelerated investment rate, and we expect margins to bounce back from fiscal 2017 onwards, though the company has said that pretax income margins will see the primary benefit of this bounce in the near term.

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