We wrote about IBM in detail in a Macro Wrap post last month, highlighting an interview with Jim Chanos where he pointed out the accounting gimmicks many large cap tech stocks have been using to maintain earnings growth. Our key takeaway:
Looking at this quarter, revenues missed estimates about 4%, while EPS beat again. It’s much harder for management to massage revenues than earnings, so management pulls the necessary levers to meet or beat that EPS estimate. But the stock’s reaction this quarter shows an investor community that has run out of patience.
IBM experienced particular difficulties in the BRIC countries, where revenues were down 15%, 12% adjusting for currency, led by China down more than 20%. What I found notable on the conference call was that IBM management tried to strike an optimistic tone by highlighting its EPS and free cash flow targets – precisely the metrics that are easier to influence than revenues. In short, I expect many more acquisitions in the next year from IBM, as it furiously tries to meet subjective accounting targets, even as its overall business shrinks.
Since that earnings report drop (which was on IBM’s largest volume in more than a year), IBM has inched its way higher as the broader market has rebounded, stalling this week just shy of the earnings gap at 186.73:
[caption id="attachment_32795" align="alignnone" width="600"]
IBM daily, volume lower panel, Courtesy of Bloomberg[/caption]
IBM is in an obvious downtrend of lower highs and lower lows. Given the obvious fundamental headwinds (especially internationally, where IBM gets more than half its revenues), the fact that the CFO recently retired, and the overall lack of revenue growth for more than 5 years, we view this rally as a great opportunity for a trade entry for those who missed the move lower on earnings:
TRADE: IBM ($185.75) Bought Dec20th 190/180/170 Put Fly for $3.60
-Buy 1 Dec20th 190 Put for 5.38
-Sell 2 Dec20th 180 Puts at 0.99
-Buy 1 Dec20th 170 Put for 0.20
Break-Even on Dec20th Expiration:
Profits: Between 186.40 and 173.60 of up to 6.40, with max profit of 6.40 at 180
Losses: Up to 3.60 between 170 and 173.60, and between 186.40 and 190, with max loss of 3.60 below 170 and above 190.
Trade Rationale:
IBM had not breached the $180 level since early 2012, and the convincing break after earnings was certainly a major technical breach. Having said that, the recent rally above $180 likely sets that level up as important once again on the downside, and we’re targeting a move down to there over the next month. IBM rarely moves quickly outside of earnings, which is why we chose the in-the-money put fly structure for this short delta trade.