IBM – Blue’s Club

by riskreversal December 6, 2016 10:14 am • Trade Ideas

Back in early August, we attempted to lay out a bullish case for shares of IBM:

IBM is a cheap stock at 12x expected 2016 eps and pays a dividend with a current yield of 3.45% which could be two of the reasons for the stock’s recent relative out-performance. The company is in the midst of a fairly epic revenue decline, with 2016 expected to be its 5th consecutive decline from its peak of $107 billion to $80 billion this year, but working very hard to move into faster growing businesses like its cognitive computing division (Watson). The good news though is that the rate of the sales decline is decelerating to an expected 3% in 2016 with consensus eyeing flat sales in 2017 & 2018.

I suspect one thing that could really catalyze the shares would be some sort of corporate action, possibly a trans-formative acquisition or the prospects of a split like of their hardware and software/services businesses like we saw from Hewlett Packard last year, with just this week rumors swirling around HPE (faster growing bit) being taken private, shares are at an all time high.

This October it will be CEO Ginni Rometty’s 4 year anniversary, and since then the stock is down about 20% vs the SPX up about 50%. I suspect the 30 year veteran of IBM needs to start thinking in terms of job security as a coach of a college sports team would where the athletic director was willing to give the new hire the benefit of their first class running their course.

So not much has changed since the post in August.  IBM is basically 1% away from where it was then. So now what?… 

The company’s Q3 report didn’t offer a ton of clarity about the company’s growth initiatives in the cloud. While revenue growth was impressive, they seem to be gaining share by competing on price, resulting in disappointing profitability.  Things remain clear as mud as it relates to IBM’s transition to what they call “strategic imperatives” like cloud services. I would note that CEO Rommety’s appointment, as one of 16, to the President-elect’s Strategic and Policy Forum, following Rometty’s open letter to Trump the week after the election, and Trump’s tough rhetoric on the campaign trail towards Jeff Bezos (regarding the potential antitrust issues with Amazon’s ever growing business lines), might put IBM in the catbird seat for government contracts, or at least from those looking to broaden out from their dependence on Amazon’s AWS.

Yeah the company will continue to win high profile corporate clients for the public cloud and As-A-Service offerings like the one from American Airlines last week, but investors will continue to be less than impressed if their margins demonstrate they are winning solely on price.

Near term, as we head into the New Year with investor optimism for what the Trump administration will mean for corporate taxes, repatriation and infrastructure spend, a company like IBM should be a clear beneficiary. The company’s next identifiable catatlyst will be their Q4 results in mid Jan. Eyeing an early 2017 gap fill back towards $180, with defined risk might make sense:

IBM 5yr chart from Bloomberg
IBM 5yr chart from Bloomberg

So What’s the Trade?

*IBM ($160.25) Buy the Dec30/Feb 165 call calendar for 2.40
  • Sell 1 Dec30th 165 call at .80
  • Buy 1 Feb 165 call for 3.20

Rationale – This trade risks 2.40 and targets a move back towards IBM’s 2016 highs to close the year. Following the expiration of the Dec30th calls there’s opportunity for additional positioning as that short call can either be rolled as a calendar or rolled to a higher strike in February to create a vertical. If the stock goes lower than here the most that can be lost is 2.40. The ideal situation is a close at or near 165 for 2016, which can then be closed for a profit or used a great set-up for a very cheap long exposure for a breakout above that level in early 2017.