IBM – Into the Big Blue Yonder?

by Dan January 12, 2018 1:28 pm • Trade Ideas

IBM will report their Q4 results Wednesday, January 17th after the close. The options market is implying about a 3.5% move between now and next Friday’s close, or about 3% one day move following results, which is well shy of the average one day move over the last four quarters of about 5%. The stock rose nearly 9% on October 17th after the company reported better than expected Q3 results and forward guidance, but oddly spent the next month filling in the entire earnings gap:

IBM 1yr chart from Bloomberg

The stock has since made a new high above the Oct levels and has gotten off to a fairly good start in 2018, up nearly 7% on the year in just two weeks. The stock has rallied 8 consecutive days, its longest running win streak in 5 and a half years. What gives? Is it merely a Dog of the Dow play? While that dividend yield at 3.65% looks fat, the commensurate rise in interest rates might start to make it look less attractive. Is it the weakness in the U.S. dollar? considering the company gets two-thirds of their sales overseas, the dollar’s weakness (nearing the 2017 lows), despite expectations for higher rates in 2018 could be viewed as a massive tailwind. Or is it crypto-fever? WinterGreen Research estimates that IBM took home more than 30% of the $700 million market for blockchain products and services (per Bloomberg), which research firm Markets & Markets sees reaching close to $8 billion a year by 2022 (per Fortune.com).

In the company’s third-quarter release they touted the growth of what they call “strategic imperatives”, which includes their enterprise cloud offerings and cognitive solutions like Watson, which makes up nearly 50% of their trailing 12 months sales and grew 10% over that period.

The company also returned $2.3 billion to shareholders in dividends and buybacks, just shy of the $2.5 billion in free cash generated in the quarter. Their current buyback authorization leaves only $1.5 billion so we should expect a re-up very soon.

One thing is clear, IBM is NOT one of the large beneficiaries of corporate tax cuts, in Q3 their effective tax rate was only 11%, a large contributor to their earnings beat, on the Q3 call the company guided analysts to expect “IBM’s ongoing operational tax rate would remain in the range of 15%, plus or minus three points“.

So what to expect into the print? A beat and raise will clearly be viewed positively, I suspect it depends just have much of the eps is the result of low taxes and dollar tailwind vs the health of the strategic imperatives. If they are able to show and guide towards an acceleration in their faster growing higher margin businesses then the stock is likely too cheap. A full year guide to yoy revenue growth, which would be their first in seven years might just do the trick.

So What’s the Trade?

IBM ($164.30) Buy the Feb 165 / 175 call spread for $3.00
  • Buy 1 Feb 165 call for 4.15
  • Sell 1 Feb 175 call at 1.15

 

Breakeven on Feb expiration:

Profits of up to 7.00 between 168 and 175, max gain of 7 at 175 or higher

Losses of up to 3.00 between 165 & 168, total loss of 3 below 165

Rationale – This trade breaks-even at 168, a decent amount higher than the current stock price but captures next week’s earnings event. It risks only 2% of the underlying and targets a move higher to 175. If the stock disappoints on the event 3.00 is the maximum potential loss, much less than the implied move itself.