Earlier today we had some thoughts on the EMC / DELL link up (A Shell Game of Declining Levered Assets), Spoiler Alert: we were not complimentary. The proposed deal, if consummated in the coming year, would mark the largest tech merger ever, at a time when large old tech hardware companies (like HPQ) have been pressured to split similar businesses that EMC & DELL are combining. It seems odd to me. Especially when you consider that companies like IBM and even ORCL have been deemed too bulky and staid to ever again produce organic growth.
Investors in IBM would not take too kindly if the company added to their $38 billion ($30 billion net of cash) in debt (25% of their $148 billion market cap) to do a mega deal. I suspect investors would rather see a HPQ sort of split, or a scenario not too different to when GE sells off non-core assets and uses the proceeds to buy back stock. IBM had been using most of its free cash flow to buyback shares and pay its dividend (prior to this year), but has since cut its buyback as the company is expected to have its first 10% plus sales decline (this year) in more than a decade.
What about an acquisition in a fast growing cloud based business for IBM, or security software? I suspect the expense would be prohibitive for a large deal like SalesForce (CRM). And a smaller deal like Palo Alto Networks (PANW) would not move the needle for years on their $83 billion in expected sales.
What’s interesting about IBM’s price action off of its financial crisis lows is that its all time highs (in late 2013) was up about 210% from its 2009 lows, a similar percentage that the S&P 500 topped out at earlier this year. The series of lower highs over the last couple years has been preceded and followed by a series of earnings and sales misses and no shortage of ineffective restructurings:
It’s nearly impossible to look a the chart above and not come to the conclusion that at least a further 10% drop is in the cards in the coming weeks/months, possibly as much as 20% (down to $120).
The stock is down 5.5% on the year, even after its 8% rally in the last 10 days. The next identifiable catalyst will be Q3 earnings on October 19th, after the close. The options market is implying about a 4% one day move, which is essentially in line with the 4 qtr avg move of about the same. The ten year average post earnings move is about 3.5%.
So what’s the trade?…
Regular readers know that it is not our bag to try to play for a dead cat bounce in a stock like this. We think the company is currently screwed and has few shareholder friendly corporate action outcomes at its disposal in this environment.
A quick look at the year to date chart shows what would be a layup of a short entry at $160 (red line). which also corresponds with the stock’s breakdown level in late July, and its 200 day moving average (purple line). This should serve as staunch technical resistance. For those who might look to be more aggressive, $155 will do:[caption id="attachment_57592" align="aligncenter" width="600"] IBM ytd chart from Bloomberg[/caption]
For those that can’t wait, implied vol isn’t likely to come in much between here and earnings, and with the stock at $151.50, the Oct 23rd 150/140 put spread at $2.10 looks like a reasonable buy for the convicted. The challenge with a week remaining until earnings is being too soon. We will circle back next Monday.
Again this trade up corresponds with our investment worldview. Are there positive scenarios that we are just missing? Of course. Would an inline quarter and decent guidance that shows stabilization help sentiment? Of course, but we would expect this to be short lived as most other relief rallies over the last couple years.