IBM

First published on December 24, 2020 as a guest article on freaky finance. You can also find the joint video with Vincent there.

IT dinosaur, Dividend Aristocrat and turnaround candidate for 2021?!

Technology, endless possibilities. In the future, taxis will drive autonomously, packages will be delivered by drone and even the trickiest heart surgery will be handled by a robot. What sounds like a crazy science fiction movie will probably be reality in a few years. And why not?

Artificial intelligence is efficient, makes no mistakes, doesn't ask for a raise and doesn't go on vacation either. According to a study by the University of Oxford, artificial intelligence will take over around 47 percent of all jobs in the next 25 years - at least in the more developed countries. Digital transformation has already been a topic here on the blog as well. Even today, an ordinary smartphone packs more computing power than the rockets that flew to the moon back then. So we're currently experiencing a digitalization revolution.

As a long-term investor, you naturally want to profit from this enormous future potential. Of course, you can't go far wrong with companies like Apple, Microsoft or Alphabet, but if you're looking for a high dividend yield and the ultimate turnaround candidate, you should definitely take a closer look at IBM.

So today, let's take a look together at the history, the business model and of course the future prospects of the American IT and consulting company.

The origins and business model of International Business Machines Corp.

For this, let's travel back in time to 1849. The Palatinate still belonged to the Kingdom of Bavaria back then, but it wanted to break away with the Palatinate uprising. Without further ado, some families decided to leave the country - including the Holleriths, who emigrated with their two daughters from the Palatinate municipality of Großfischlingen to the USA.

Almost 11 years later, on February 29, 1860, the family had another child, their first son Herman. He first attended the College of the City of New York and, at the age of 19, completed his engineering degree at Columbia University. In 1880 he took part in the American census, which back then took a sluggish 7 years. Hollerith recognized how inefficient this work was and from then on looked for a way to speed up such processes.

On a train ride he watched a railroad conductor punching passenger characteristics into the ticket. This prevented tickets from being secretly passed on. From this idea, the young engineer developed his innovative tabulating machine, which could read data with the help of punch cards.

After some tests, his machine was used for the census in 1890. Now it took only 43 machines to count the entire American population within 2 years. No wonder this innovation quickly made the rounds and Hollerith decided in 1896 to found his own company. The Tabulating Machine Company was born.

Business was very good, and over the years he was able to develop his machines significantly further. Finally, on June 16, 1911, Hollerith decided to sell his company for the proud sum of 1.2 million US dollars (equivalent to about 33 million today). More precisely, the Tabulating Machine Company was merged with three other up-and-coming companies to form the new Computing-Tabulating-Recording Company.

Shortly afterwards, Thomas John Watson became head of the company, which he would lead and significantly expand over the following decades. The company focused more and more on the business customer segment, which is why in February 1924 it decided to rename itself International Business Machines Corporation.

From the punch card to the quantum computer

Time and again, Watson had to make bold decisions that would later pay off. For example, during the terrible Great Depression, he decided to invest massive amounts of money to keep production going no matter what. While some competitors went bankrupt, IBM was able to secure lucrative government contracts and emerged from the crisis as the clear winner.

During and after World War II, IBM cleverly used military investment to continue research into computer technology. It left the outdated punch card systems behind and now turned to electronic data processing. With the IBM 604, it launched the first electronic calculator in 1948. In the 1960s it significantly expanded its monopoly position when it released the first general-purpose business computer, which met with great acclaim worldwide.

The floppy disk, the first ATM, the first portable computer and the laser printer were followed by many more groundbreaking innovations from IBM. The '80s also started out quite promisingly with the introduction of the personal computer, which was launched in response to the successful Apple II.

IBM was undoubtedly Wall Street's darling. But as several competitors gradually brought cheaper computers to market, IBM lost its market leadership. IBM's bureaucratic structure and some momentous management mistakes ultimately led to a catastrophic corporate crisis.

To survive, it had to lay off around 200,000 employees and completely reposition itself. It increasingly turned to the software and IT services sector. As part of this, it acquired the consulting firm PricewaterhouseCoopers Consulting in October 2002, and in 2005 completely withdrew from the unprofitable PC business and sold that division to Lenovo.

In the following years, IBM focused more and more on quantum computing, cloud solutions, artificial intelligence and the Internet of Things. In addition, its consulting services make it one of the leaders in its industry. Today IBM employs over 352,600 people worldwide and divides its business mainly into five different segments:

• Cloud & Cognitive Software: This brings together IBM's software platforms and solutions that provide various cloud, data and AI solutions. (approx. 30 percent of revenue)

• Global Business Services: In this segment, IBM focuses on services in consulting, business process and application management. (approx. 21.5 percent of revenue)

• Global Technology Services: Here it provides comprehensive IT infrastructure for business customers. (approx. 35.5 percent of revenue)

• Systems: Here it offers customers innovative infrastructure platforms to meet the requirements of hybrid multi-cloud and enterprise AI workloads. (approx. 10 percent of revenue)

• Global Financing: As the name suggests, in this segment IBM handles all kinds of financing deals to make it easier for its customers to acquire systems and software solutions. (approx. 2 percent of revenue)

All in all, you could say that IBM has proven several times over the years that it's adaptable and can weather longer dry spells.

Future prospects

Before I go into more detail on how IBM might develop in the future, I'd like to take a look at the figures for the most recently published quarter (Q3 2020). Revenue fell 3 percent compared to the prior-year quarter to 17.6 billion US dollars. While the four other segments developed negatively, Cloud & Cognitive Software grew by 19 percent.

This growth is undoubtedly also thanks to the costly acquisition of Red Hat, the world's leading provider of open source cloud software. In the summer of 2019, IBM closed the 34 billion US dollar acquisition. I'm confident that this acquisition made sense and will pay off in the long run, but IBM really had to dig deep into its pockets for it.

And that brings us right to the topic of future prospects. In my opinion, the new CEO Arvind Krishna has a lot of work ahead of him. He's seen as the great hope who's supposed to get the IT giant back up to speed. As part of this, the company should focus on one profitable business area and put all its combined strength into it. Dabbling a little here and there just doesn't work, which you can probably also see in the stock chart, which has been in a downward slide since 2013.

Just recently he announced an important step in the right direction: By the end of 2021, IBM wants to split up and take its IT infrastructure business public as an independent company. Going forward, IBM itself wants to focus more on the hybrid cloud and artificial intelligence.

As I said, if these and subsequent steps turn out to be successful, IBM could become a wonderful turnaround candidate. For my part, I'll be watching this over the next few quarters and then possibly build a smaller position.

IBM has been a Dividend Aristocrat since 2020

IBM (or back then still CTR) shareholders received their first share of profits as early as 1913. Since 1916, the company has managed to pay out a dividend every quarter. It couldn't always be raised, but that's still a solid achievement over such a long period.

This year IBM - despite Covid, which led to many dividend cuts elsewhere - rose into the exclusive circle of Dividend Aristocrats. You earn this coveted title with a history of at least 25 consecutive years of dividend increases.

The current dividend yield is a proud 5.17 percent - which is certainly also due to the falling share price.

Dividend growth over the last 10 years is still a decent 10.3 percent, whereas over the last 5 years the dividend was raised by “only” 5.7 percent per year.

In my opinion, though, the payout ratio, currently 73.7 percent, could stand to be lower. Generally speaking, I would even be in favor of IBM cutting or pausing the dividend in order to position itself, strengthened, for a successful future.

Conclusion

The IT giant International Business Machines Corporation has a long and fascinating history behind it, one that is undoubtedly unmatched. The stock, on the other hand, has weakened over the past few years, which is why the new CEO now has a lot to do. The renewed restructuring could get IBM back on track in the medium term and restore its former strength.