Making IBM Great Again With Artificial Intelligence

The larger a corporation becomes, the more processes are needed to control things, and sometimes you end up with a buzzword-laden monstrosity that’s nearly impossible to figure out. Warren Buffet often advises to “invest in what you know,” which is perhaps why IBM turned out to be one of his biggest investment mistakes. As longtime IBM shareholders, we always need to remind ourselves why we still hold this flailing computing stock. It’s because of dividend growth.

IBM has not only paid a dividend for the past 25 years but increased that dividend every single year. Over the past 10 years, dividend growth has averaged 11.6% per year, handily outpacing inflation. It’s why IBM is one of the top-ten stocks to hold based on our Quantigence dividend growth investing strategy.

Quantigence - a dividend growth investing strategy
IBM’s high Q-score – Credit: Quantigence

About once a year we like to check in with each of our core holdings to see what’s been going on. It’s been two years since we looked at IBM’s blockchain aspirations, so let’s start with the big news – a new leader at the helm.

The Legacy of Ginni Rometty

Buffet announced his $10 billion IBM position in November of 2011, two months before Ginni Rommetty assumed her role as IBM’s Chairman, President, and Chief Executive Officer. It is never advised that the same individual occupy both the Chairman and CEO roles for any given company because it’s a conflict of interest when the CEO is supposed to answer to the Board. A recent article by HBR discusses the problem, stating:

Splitting the CEO and board chair jobs between two people can help strengthen the quality of questions the corporation asks itself. When those questions remain weak, the organization is less likely to develop strategies that mitigate risk.

Maybe somebody should have asked IBM’s Board why Ms. Rometty continued to receive multi-million-dollar bonuses over her tenure while the share price floundered, even when taking dividends into account.

Credit: Los Angeles Times

Sure, she was finally able to engineer the “turnaround” after IBM sales declined for more than five years straight under her well-paid guidance, though some might argue it was a non-event.

Credit: Guru Focus

As news of a pandemic was hammering the markets in April of 2020, IBM’s shares popped on the news that Arvind Krishna would take over the reins from Ginni Rometty after leading IBM’s acquisition of Red Hat, something we talked about in a piece titled IBM and Red Hat – WTF is a Hybrid Cloud? Mr. Krishna believes that hybrid cloud and AI are the way forward for IBM, so it seems logical that robotic process automation would be a key part of that initiative.

Any technology that can reduce the costs of existing manual operations by 25% to 40% or more without changing existing systems, yet improve service and generate return on investment (ROI) in less than a year, can truly be described as transformational and disruptive.

Credit: Ernest and Young

IBM and Robotic Process Automation

From the very first moment you start looking at IBM, things seem behind the times and wasteful. Simply Googling the company’s name shows marketing resources being wasted.

Giving money to Google for ads that serve no purpose – Credit: Google search results

The whole thing reeks of “we’ve always done it this way,” though they’ll go to impossible lengths to convince people otherwise. Maybe the senior executives responsible for “IBM’s revenue, profit, and business development” should spend less time pontificating about gender pronouns and more time figuring out how to grow revenues in high-growth areas such as robotic process automation (RPA), the fastest-growing software subsegment officially tracked by Gartner .

We’ve talked before about the tremendous growth and success of companies like Automation Anywhere which was the first RPA vendor to partner with IBM.

IBM selected Automation Anywhere in 2017 for its superior enterprise technology, strong business model and its vision. IBM RPA is the only RPA product that IBM logos and sells as their own.

Recently, IBM Services talked about how the ‘big three’ RPA vendors (Automation Anywhere, Blue Prism, and UiPath) are now supported by its own platform, “Essentials for Automation.” Is it too much to ask for IBM to compete in robotic process automation as opposed to supporting the biggest beneficiaries of RPA growth? While their automation executives will probably say they’ve “already moved past that” and on to the next buzzword – hyperautomation – it appears that IBM has made a move into RPA with their recent acquisition of Brazilian RPA firm WDG Automation.

Terms of the deal weren’t disclosed, but an article by ZDNet talks about the trend of large enterprise vendors acquiring smaller RPA firms (Microsoft with Softmotive and Appian with Novayre). The article goes on to talk about how “WDG Automation’s portfolio includes RPA, automation, interactive voice response, and chatbots, as well as technology to create automations without IT help.”

In the latest earnings call, IBM says the acquisition “advances AI-infused automation capabilities into our cloud packs.” We can’t glean much from that statement either. What IBM may be choosing to do here is keep their friends close and their enemies closer. Supporting the “big three” means they can now learn more about their mistakes. According to Ernst & Young, as many as 30 to 50% of initial RPA projects fail. IBM can now step in and offer to solve the failed implementations with their own RPA solutions instead of spending billions of dollars to acquire any of their largest competitors. There are also many smaller RPA startups out there which could make for additional RPA acquisitions. The question we have is, what’s been happening with Watson?

IBM and Artificial Intelligence

Is IBM Ready to Dominate Radiology With AI? we asked back in 2017, noting their strategic acquisitions of medical data. In fact, more than $4 billion was spent on acquiring health-related technology and data providers in just a year’s time. A year later, we posed a similar question – Is “IBM Watson Health Imaging” the Future of Healthcare? 

Not according to an article by FierceBiotech last year which talked about how IBM’s beleaguered Watson Health division now has a new leader who is doing the typical come to Jesus talk about getting back to basics, doubling down, being super focused on execution, IBM’s great work on Apollo, trusted adviser relationships, and other platitudes that mean very little. (For weary IBM investors, it’s almost unbearable.) The author of the article talked about how “Watson’s early stages have been hampered by interoperability concerns and issues in translating disparate data sources into something it could use.”

IBM’s AI capabilities have been personified by IBM Watson, that kooky machine that answers questions on Jeopardy. We’ve been hearing all these promises about what Watson can do but haven’t heard much about the execution side of things. Plenty of enterprise AI startups like Sentient and Vicarious appear to be growing large businesses around offering industry agnostic solutions to a broad set of enterprise clients. Has IBM Watson really lived up to its potential?

In a recent speech by IBM’s new fearless leader, he talks about the release of “AI for IT” which relies on Watson AI Ops to identify problems in organizations by monitoring logs. That’s something that Splunk (SPLK) has already built a $26 billion company around. Again, IBM seems to be chasing markets that others have been already reaping the rewards from. Or you could argue that IBM simply waited for everyone else to work the kinks out and now they’re moving into these spaces as a formidable competitor because nobody ever got fired for buying IBM.

By now, you might be wondering why we would be holding shares of IBM while being so critical of their business. The answer lies in the free cash flows they’re generating which help grow that dividend income. They have plenty of time and money to finally move past the eight-year “strategic imperatives” wankathon and become a true technology leader that’s able to grow their dividends in the double digits because earnings are growing at the same rate.

IBM’s Safe Dividend Growth

In 2019, IBM generated $11.9 billion in free cash flow – the cash left over after a company pays for its operating expenses and capital expenditures. Of that, they returned $5.7 billion to investors in the form of dividends. This reflects a payout ratio of 48% (5.7 / 11.9 = .48) which means there’s lots of wiggle room to continue growing the dividend.

Let’s say IBM decides to only grow their dividend by 5% going forward because of the uncertainty surrounding “the rona.” For those of us who rely on dividends for income, that’s still enough growth to offset inflation. If earnings stayed the same at $11.9 billion, IBM could raise that dividend by 5% for ten years after which the payout ratio would start to approach 80%. That’s the sort of safety we’re looking for in a dividend growth stock.

Even if they can’t manage to achieve double-digit revenue growth, maybe they can trim some of the oxygen thieves on staff who manage to keep themselves gainfully employed while subtracting value from shareholders. If the most visible person in the firm flouts their incompetence to the world and gets richly rewarded for it, odds are that others are doing the same thing.

Conclusion

If we didn’t have an objective strategy for stock selection – Quantigence – we probably would have dumped Big Blue a long time ago, if for no other reason than to protest how poorly the company has been run. At least according to Crunchbase, IBM Ventures hasn’t made an investment since April of 2018. Maybe it’s time IBM focuses less on appearing woke and more on becoming the great technology leader they used to be.

Here at Nanalyze, we hold the lion's share of our investing dollars in a portfolio of 30 dividend growth stocks. Become a Nanalyze Premium subscriber to access our report on Quantigence - A Dividend Growth Investing Strategy. We'll show you how we selected our 30 stocks and teach you how to build your own dividend growth stock portfolio.

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