#The Ratings Game: IBM stocks heads for one of its worst days in Big Blue’s long history as a public company

IBM attempted to divert investors’ and analysts attention away from its current numbers with two-year forecasts and a focus on adjusted free cash flow, but it did not seem to work.

“It’s rarely a good sign when a company starts reporting an “adjusted” free cash flow metric (isn’t “adjusted free cash flow” an oxymoron?),” MoffetNathanson analyst Lisa Ellis wrote in a note Friday morning.

Ellis did the math on the adjustments and showed that counting the billions in restructuring charges that IBM is trying to strip away shows the same lack of earnings growth that IBM’s other numbers show.

“So, even after undertaking major portfolio moves including the acquisition of Red Hat and the planned spinout of the managed infrastructure services business, IBM is expecting 2022 FCF to be, at best, ~flat with 2019, and down about 25% from where it was 10 years ago,” Ellis summarized. “That level of free cash flow deterioration is concerning for any company. For a company that pays a hefty ~$6 B dividend and has major investments required to bolster the company’s positioning in cloud, it’s even more concerning.”

That dynamic leaves IBM limited in its ability to change its course, Ellis wrote.

“We estimate that IBM will only have about $2.5 B and $5.5 B of excess [free cash flow] available for major investments (e.g., additional M&A) in 2021 and 2022, respectively. By comparison, the analogous figure was $13 B in 2010 – so there’s been a ~60% drop in IBM’s cash flow capacity for major investments over the past decade, at a time when IBM desperately needs to invest to improve its positioning in must-win areas like cloud,” the analyst wrote, with emphasis.

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Ellis maintained a sell rating and $115 target price, a common theme from analysts Friday morning as almost all chose to maintain their ratings and targets on the stock after the results. UBS was one of the few to tweak their models, dropping the IBM price target from $125 to $122, with a similar argument to Ellis about the inability to make moves hampering its growth.

“Given cash flow constraints resulting from restructuring cash costs ($3B in ’21 and $1B in ’22), commitment to its annual dividend (~$6B) and roughly $7B in debt repayments, we believe it is unlikely that future M&A will be a material rev driver in CY21,” UBS analysts wrote “As such, we estimate an unlikely ~ 200 bp acceleration in organic growth is needed in CY22 to achieve management’s lofty mid-single digit revenue target at “RemainCo” relative to our forecast.”

Analysts doubted IBM’s forecast of revenue growth in mid-single-digits at IBM after it strips away one of its large businesses in a spinoff even before the results were released Thursday. After the results, they are still waiting for proof.

“While the long-term model laid out by IBM is positive, investors (and us) would like to see some of these levers showing up in the near-term performance in way of revenue stability,” Evercore analyst Amit Daryanani wrote, while maintaining an in-line rating and $135 price target.

Not all analysts were put off by IBM choosing to focus on adjusted free cash flow and projecting revenue growth out of line with its historical performance, as JPMorgan analysts called it “a real positive that the new CEO is serious about creating a culture of delivering sustainable revenue growth and FCF instead of manufacturing EPS.”

Still, even those analysts — who do not rate IBM “for policy reasons” — are rather pessimistic about the road ahead for IBM.

“While we see a path to revenue growth in 2021, we expect near-term results to be weighed by macro and restructuring, which pushes down our estimates,” they wrote.

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Analysts as a whole rate IBM as a hold, with five of 16 analysts tracked by FactSet having a buy rating, nine calling it the equivalent of a hold and two rating the stock a sell. The average price target as of Friday morning was $137.29, as shares traded for less than $120.

IBM stock has declined more than 17% in the past year with Friday’s drop factored in, as the Dow Jones Industrial Average
DJIA,
-0.27%
— which counts IBM as a component — has added 6.8% and the S&P 500
SPX,
-0.12%
has gained 16%.