Buffett bailed on IBM: Is Watson next?

In the 1968 movie, 2001: A Space Odyssey, the spaceship’s advanced cognitive computer, HAL — which is “foolproof and incapable of error” — suffers a malfunction that leads to the derailment of the mission. International Business Machines Corp. (IBM) has been commonly associated with the naming of HAL (attributable to movie myth), but in reality, IBM’s enhanced computer solutions may not be enough to save its mission to drive revenues from its downward trend as a short position. 

IBM, the Armonk, New York-based company founded in 1924, has been faced with a drastic and lengthy transition from its prior business segments due to its declining sales of its legacy server hardware. This led to IBM’s “strategic imperative” mission to reinvest and focus within emerging markets, including cloud computing, data analytics, mobile technologies and social and security services. This shift in conjunction with its seemingly flat year-over-year reported margins have led to investor hesitancy and apprehension. 

Its other business segments have been shrinking faster than the growth of its new business initiatives, as its cognitive solutions segment is the only one of its five major divisions functioning with improved margins. IBM’s reported Q1 2018 earnings of $2.45 per share on revenue of $19.1 billion vs. the consensus estimate of $2.40 per share and revenue of $18.7 billion led to immediate investor unhappiness with both its margin and its strategic restructuring plans. While it announced better-than-expected earnings and revenue, IBM reaffirmed guidance for 2018 earnings of $13.80 per share. This was IBM’s first revenue growth after 20 straight quarters of decline, and the chances this will continue throughout 2018 did not impress, leading to an $8.77 (6%) opening gap lower on April 18.  

Although there was some success reported by its cloud and autonomous database products in relation to its competitors (a growth of 15%) the market was still skeptical. Viewed in the most favorable light, this can be seen as a mixed success, as Warren Buffett’s Berkshire Hathaway (BRK-B) liquidated its entire stake of IBM in Q4 2017. IBM’s overall lack of growth has been evidenced through its Q3 2017 numbers, down 2% for the year and its Q1 2018 unsatisfactory reassurances. IBM’s finance chief James Kavanaugh noted that its Q1 2018 numbers were lower due to its storage segment. IBM’s statement that it has “all the confidence in the world” that it can improve the storage segment by the second half of 2018 seems eerily reminiscent of HAL’s “enthusiasm and confidence” in 2001’s fated mission.


TECHNICAL PICTURE

The lack of enthusiasm for an IBM recovery by the markets is matched by a challenging technical picture (see “IBM death cross”). The February sell-off pushed IBM below both its 50- and 200-day simple moving average (SMA). This followed a golden cross-inspired rally in January. Although IBM rallied above both its 50- and 200-day SMA in March, it failed to take out its January high. On April 17, IBM failed to take out the March high and set a double-top resistance level at $162 as it awaited its post-close Q1 2018 earnings announcement. 

The disappointing announcement coupled with technical weakness led to further losses. With its stock trading below both its 50- and 200-day SMA, IBM entered a death cross on May 11 as the 50-day SMA crossed below the 200-day SMA. The next support area is the 2017 low of $139.13, but strong downward momentum should be able to take that out.  

The author has short holdings in IBM.