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How to Protect your Wealth by Investing in AI Tech Stocks

3 Signs IBM Is in Big Trouble—and How the Company Masks It

Companies / Tech Stocks Aug 04, 2016 - 07:00 PM GMT

By: John_Mauldin

Companies

BY TONY SAGAMI : I got a lot of positive feedback on my recent column, “Anatomy of a Successful Short Sale.” It’s no surprise, though. Spotting failing companies is as useful and lucrative as uncovering hidden gems.

Now let’s put theory into practice and take a look at a stock that my subscribers are currently shorting.

That stock is IBM.


IBM recently reported its quarterly results. The see-no-evil analysts on Wall Street jumped for joy at what I think were terrible results.

What was so terrible? Here are the reasons why I expect this stock to fall.

Acquisitions to hide falling revenues

How about this: IBM has reported falling revenues for 17 consecutive quarters.

IBM pulled in sales of $20.2 billion last quarter. But that’s 2.7% less than a year ago and 25% lower than in 2011.

The weakness is widespread:

  • Global Business Services had revenues of $4.3 billion, down 2%.
  • Technology Services & Cloud Platforms (includes infrastructure services, technical support services, and integration software) had sales of $8.9 billion, down 0.5%. 
  • Systems (includes systems hardware and operating systems software) had sales of $2 billion, down 23.2%.
  • Global Financing (includes financing and used equipment sales) had sales of $424 million, down 11.3%.
  • With all that red ink, acquisitions are the only way you can make yourself look good. IBM has bought 11 companies worth $5 billion so far this year.

In fact, it has spent more on acquisitions in the last 12 months than ever before.

The acquisitions have boosted the Q2 revenues of $20.2 billion by $400 million. So, the results would have been even uglier without them—a 5% decline instead of the current 2.7% growth.

Pro forma calculations and massaged profits

IBM reports its earnings on a pro forma basis instead of a GAAP basis (I wrote about this tactic in detail in this column). This way it can use “accounting magic” to prop up its pro forma profits.

IBM reported better-than-expected “pro forma” profits of $2.95, which was above the average forecast of $2.88. On a GAAP basis, those profits shrink to $2.61 a share.

Still, even those phony pro forma calculations are 25% lower than a year ago.

A cash hoard of borrowed money

IBM is proud of its cash hoard, which increased from $7.6 billion in Q2 of 2015 to $10.6 billion today. That cash, however, didn’t come from operating profits. It’s borrowed.

IBM had $33 billion of debt a year ago. The company took on $11.5 billion more and now owes a staggering $44.5 billion.

That $10.6 billion cash isn’t going to last long. IBM is burning through it. The company had $3.4 billion of operating cash flow in Q2 but spent $5.9 billion on:

  • $1.0 billion on capital expenditures
  • $2.8 billion on acquisitions
  • $1.3 billion on dividends
  • $800 million on share repurchases

That’s $2.5 million of negative operating cash flow. Only IBM’s debt makes it possible. It’s a big warning sign of a company in trouble.

By the way, competitor Infosys warned that Brexit could hurt its business. IBM, however, adopted the see-no-evil defense: “Brexit didn’t help, but from everything we’ve seen we haven’t changed our view,” said CFO Martin Schroeter.

I think that IBM’s day of reckoning is near…

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Markets rise or fall each day, but when reporting the reasons, the financial media rarely provides investors with a complete picture. Tony Sagami shows you the real story behind the week’s market news in his free weekly newsletter, Connecting the Dots.

John Mauldin Archive

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