If you’re like me, and you watched the final round of the Master’s golf tourney on Sunday, then you were subjected to what might be considered cruel and unusual punishment at the hands of IBM’s marketing team in what amounted to dozens of mind numbing commercials for their talking computer called Watson. What is Watson you ask? Wasnt that the thing that won Jeopardy? And why do the marketing peeps at IBM think it is such a big deal? Well, it’s IBM’s so called cognitive computing engine that the company hopes can be applied to dozens of industries, transforming IBM’s lagging sales of legacy products to businesses, per Bloomberg:
The Watson unit — called cognitive computing — could reach $1 billion in sales in the near-term, he said, without specifying the time frame. Watson is the fastest growing part of International Business Machines Corp.’s analytics business, he said. Those operations brought in about $17 billion in revenue last year, or about 18 percent of sales. Watson is already incremental to the business, Kelly said in an interview.
Watch IBM’s senior vice president for solutions portfolio and research who overseas Watson discuss the technology and its applications to Bloomberg’s Emily Chang last September:
I guess the main take-away for me is the part where Watson may account for a little more than $1 billion in sales of IBM’s expected $78 billion in total sales in 2016, or less than 1.5% of the expected total. So advances in artificial intelligence is still in its infancy. Meanwhile, IBM is expected to post its 5th consecutive annual sales decline, down 27% from their peak of $107 billion in 2011, and reaching annual levels not seen in more than a decade.
Back in late February I had some thoughts on IBM’s share buybacks that actually continued to grow eps from their sales peak in 2011 (around the time the company’s largest shareholder, Warren Buffett started building his stake), and since they have slowed is expected to be flat in 2016 from their 2011 eps print of $13.44:
Since Buffett bought his initial stake in IBM, the company’s annual sales have dropped 23% from $107 billion in 2011 to $82 billion last year, while consensus is calling for a 5% decline in 2016 and its second consecutive 10% eps decline and eps estimate that is expected to match 2011’s $13.45 a share. The problem is that since 2011 the company has shrunk their float by over 200 million shares, massively aiding that eps number, with most of their operating cash flow going to capital return.
Shares of IBM have outperformed the broad market in 2016, up nearly 9%, and up 28% since making a 52 week and 5 and half year low on February 11th at $116.91, draw the lines anyway you like, but the intra-day low below $120 appears to be a fairly epic double bottom, but the series of lower lows from the 2013 all time high, one in 2014, one in 2015 and possibly the move back to the downtrend at $150, set up for a great short entry:
The next identifiable catalyst for IBM will be their Q1 earnings on April 18th after the close. The options market is implying about a 5% one day move*, which is a tad rich of the 4 qtr avg one day move of 4.6% and the 10 year average move of 3.5%. IBM has declined the day following earnings in 13 of the last 15 reports. With the stock at $149.50, the April 22nd weekly 150 straddle (the call premium + the put premium) is offered at about $8, if you bought that you would need a move above $158 or below $142 to make money on the close on April 22nd, or about 5.3%.
It’s not just me wondering about the significance of Watson, Hewlett Packard Enterprise (HPE) CEO Meg Whitman was recently caught saying WTF Watson? Per Business Insider:
When asked by Network World’s John Gallant why Whitman wasn’t out talking up HPE’s own “cognitive” services, she said (emphasis ours):
Listen, they’re [IBM] doing some very interesting things. They’re buying healthcare companies and stuff, but listen, our Vertica platform is remarkable as is our Haven OnDemand platform. I put us up against Watson every day of the week here. We’re in a lot of customers where actually from a Watson perspective it’s not as far along in terms of real-world applications as you might imagine from the advertising.
You can take Ms. Whitman’s criticism with a grain of salt as a competitor. But the point is a good one. Tons of companies of working on this stuff (Google owns DeepMind, which like IBM beating Gary Kasparov in chess or winning Jeopardy, just beat the world’s best Go player, a significant advancement for AI research) But for now, IBM is merely using the potential of Watson to serve as marketing window dressing for a whole host of other crap that is not going so well at the company.
So What’s the Trade?
I suspect IBM sets up as a good near term short after such a sharp reversal, now back at the downtrend. While any positive fundamental news will likely be met with a grain of salt, another downgrade to guidance will most likely cause the stock to retrace a portion of the recent rally.
If I were inclined to trade today I would look to sell near the money weekly puts (expire this Friday) and buy next week near the money puts and look to turn the put calendar into a vertical put spread by selling a lower strike put Monday prior to earnings.
For instance, with the stock at $149.60 you could sell the April15th 148 put at 60 cents and buy the April 22nd weekly 148 put for 3.30, resulting in a 2.70 debit. If the stock is 148 or higher on this Friday’s close I could sell a lower strike put, like the April 22nd 140 puts at 1.10, and then having the April 22nd 148 / 140 put spread on for 1.60.
We will take a closer look later on in the week, but wanted to outline how I might approach this trade with 4 full trading days till earnings.