BILLIONAIRE WARREN BUFFETT INVESTS $10.7 BILLION IN IBM, MAKES HUGE BET ON TECHNOLOGY, A SECTOR HE HAS ESCHEWED

Billionaire investor Warren Buffett plowed $10.7 billion into the shares of International Business Machines Corp., making a massive bet on a technology services company after years of eschewing technology stocks.

Mr. Buffett on Monday said his Berkshire Hathaway Inc. has taken a 5.4% stake in IBM. The holding is valued at $12 billion at current prices, already reflecting a 12% gain from what Berkshire paid. The acquisition made the Omaha, Neb., conglomerate IBM's second-biggest shareholder at Sept. 30, after investment firm State Street Global Advisors.

 

How did Warren Buffett keep his $10.7 billion investment in IBM from the public? WSJ's Shira Ovide stops by Mean Street to explain. Photo: Stephanie Sinclair/ VII for The Wall Street Journal

Berkshire secretly had been accumulating the shares since March, twice receiving confidential treatment from the Securities and Exchange Commission, which otherwise mandates that big investors disclose their holdings quarterly. Berkshire made its purchases during a period when shares of the information-technology services provider hit new highs while the broader stock market convulsed.

IBM shares have surged 28% this year, outdoing a flat showing in the Standard & Poor's 500 broad-market index and making the company the fourth-biggest U.S. firm by market capitalization, after Exxon Mobil Corp., Apple Inc. and Microsoft Corp. IBM's shares closed Monday at $187.35, down three cents, on the New York Stock Exchange. Berkshire closed 1.3% lower at $113,921 a Class A share.

The investment represents the most Berkshire has ever paid for a minority stake in a publicly traded company. Berkshire has an ever-growing cash hoard that Mr. Buffett must deploy in stocks and businesses in order to meet his goal of increasing the value of his company faster than the S&P 500 index. The IBM investment, along with a purchase in the third quarter of shares in Intell Corp. by Berkshire investment manager Todd Combs, gives the conglomerate holdings in 11 of the 30 companies that make up the Dow Jones Industrial Average.

 

By investing in IBM, the 81-year-old chairman and chief executive of Berkshire appears to be departing from a long-held aversion to technology stocks. He previously professed to not understand technology companies even though his close friend and Berkshire board member Bill Gates is chairman of Microsoft. Mr. Buffett's investment track record has been built on investments in insurers, financial companies and industrial businesses, including household names like Coca-Cola Co. and American Express Co.

Mr. Buffett said he invested in IBM after reading its most recent annual report and was struck by IBM's entrenched position providing technology services to businesses. That is a characteristic he has long sought in investments, which he calls a "moat" against competition.

In an interview with The Wall Street Journal on Monday, Mr. Buffett said,  

"IBM fits all my principles…it's something we expect to own indefinitely."

He said he has completed his purchases of IBM. The SEC issues about 60 confidentiality waivers per quarter to investors, allowing them to accumulate shares without disclosures that could drive up stock prices.

Mr. Buffett said the fact that IBM stock has been trading close to its all-time high didn't matter to him.  He said.  

"What matters is what the company does in the future."

Berkshire's investment in IBM was earlier reported by CNBC.

IBM declined to comment on Berkshire's holding.

IBM, founded a century ago, has evolved from what was largely a maker of personal computers into a global provider of software and technology services for big companies and governments. By 2015, IBM aims to double its per-share earnings from 2010, receive 30% of its total revenue from emerging markets and spend $20 billion on acquisitions. 

Shares of the Armonk, N.Y., company have ridden this year's tech wave, which has pushed up stocks of many tech and Internet companies and sparked fears among some market watchers of another tech bubble.

IBM shares are trading at nearly 15 times IBM's 2010 earnings and 12.7 times its projected 2012 earnings, based on analysts' forecasts. That valuation is similar to Oracle Corp. but higher than Microsoft's forward price-to-earnings multiple of 8.5 times.

Mr. Buffett said the idea of purchasing shares in Microsoft is "off limits" to him because of his friendship with Mr. Gates.

 Bill Gates and Warren Buffet on board Berkshire Hathaway's corporate jet

Even though Berkshire bought IBM shares during a period in which they often traded near their record high, Mr. Buffett has maintained he tries not to overpay for investments. Last Friday, in a meeting with about 200 business students from colleges around the country, he said that when he buys stocks, he looks for enduring competitive strengths "and something not too expensive."

Not everyone is as bullish on IBM shares as Mr. Buffett. ISI Group analyst Brian Marshall, who has a "neutral" rating on the stock, said shares are "priced for perfection" and likely won't see a significant boost until IBM starts growing revenue more quickly. 

Mr. Buffett has long been familiar with IBM, having discussed the company's business with Mr. Gates in the early days of their friendship. Jeff Matthews, a private investor in Berkshire who has written a book about Mr. Buffett, said the billionaire's early view of tech stocks was shaped some 50 years ago when many technology firms were "untested or highly volatile companies that generally flamed out."

Mr. Matthews said.

"Mr. Buffett probably sees IBM as a company that is as hard to displace from the corporate world as Coke would be to displace from the consumer world."

On the change in how he viewed investing in IBM, Mr. Buffett said: "Sometimes business facts change and it's your job to attempt to understand them."

One change Mr. Buffett will have to keep a close eye on is IBM's management. In October, IBM announced that Virginia M. Rometty will succeed Sam Palmisano as chief executive on Jan. 1 after a nearly 10-year run at Big Blue.

Mr. Buffett said the management change didn't surprise him, as IBM has "retired people fairly young."

Mr. Palmisano has won credit for wrenching decisions, like dumping IBM's PC business in the middle of the last decade, and for using a string of acquisitions to boost the company's exposure to more profitable services and software businesses.

COMMENTARY:   I normally would not have picked up on this story, because I have eschewed IBM or "Big Blue" for what seems forever.  As you know, IBM was perceived as the evil "Big Brother" by Steve Jobs in his infamous Super Bowl commercial for the MacIntosh.  To me, IBM has represented Big Corporations and dark forces of the Illuminati, CIA and NSA.   

For me the future is mobile: smartphones that will become smarter (Apple's iPhone 4S with SIRI voice commands is a move in that direction), tablets (iPad versus Kindle Fire and B&N Nook Tablet), music players (iPods), mobile apps and the Cloud.   I have found IBM boring, mysterious, and just plain, not very exciting.   The only exception was Watson their talking super-computer which took on two human contestants on the TV game show Jeopardy.  I covered Watson in a blog post dated 

Since June 2010, Bill Gates, Warren Buffet and wife Melinda, have been talking with some of the world's biggest billionaires to raise $600 billion for charity.  Some of the billionaires they have spoken with include Larry Ellison (Oracle), Lord Sainsbury (U.K. supermarket chain) and Christopher Cooper-Hohn (U.K. hedge funds) and others.  The goal is to have these billionaires give away most of their wealth to help solve some of the world's biggest problems like disease, hunger and poverty.  Bill Gates has also invested in green technology and even nuclear reactors. Here's a copy of their "billionaire recruitment" letter sent to David Rockefeller:

Rockefeller Letter Fortune  

Bill Gates and Warren Buffet have been long-time friends, a unique relationship because of generational differences, but they are both smart, made smart investments and the two are worth a combined $100 billion.  That buys a lot of philanthropy. However, I didn't know just how chubby these two were until I did a search for pictures of the two of them together.  These two are almost inseparable.   

So why exactly is Warren Buffet so interested in IBM, and investing in the technology industry, something he has never done before?   There are very few technology companies that have cast a worldwide shadow like IBM. IBM employs more than 425,000 employees (sometimes referred to as "IBMers") in over 200 countries, with occupations including scientists, engineers, consultants, and sales professionals.  Here are a few more reasons:

• IBM was  ranked the 18th largest firm in the U.S., as well as the 7th most profitable by Fortune for 2011. 
• IBM was ranked the 31st largest firm by Forbes for 2011.
• IBM was ranked the #1 company for leaders (Fortune) for 2011. 
• IBM was ranked the #2 best global brand (Interbrand). 
• IBM was ranked the #1 green company worldwide (Newsweek). 
• IBM was ranked the #12 most admired company (Fortune). 
• IBM was ranked the #18 most innovative company (Fast Company). 

INTELLECTUAL PROPERTY

IBM holds more patents than any other U.S.-based technology company and has nine research laboratories worldwide.  Its employees have garnered five Nobel Prizes, four Turing Awards, nine National Medals of Technology,  and five National Medals of Science. Famous inventions by IBM include the automated teller machine (ATM), the flopy disk, the hard disk drive,  the magnetic stripe card, the relational database management system (RDBMS),  the Universal Product Code (UPC), the financial swap, SABRE airline reservation system, DRAM, and Watson artificial intelligence. 

CONSOLE GAMING SYSTEMS

Virtually all console gaming systems of the latest generation use microprocessors developed by IBM. The Microsoft Xbox 360 contains a PowerPC tri-core processor, which was designed and produced by IBM in less than 24 months.  Sony's PlayStaton 3 features the Cell BE microprocessor designed jointly by IBM, Toshiba and Sony.  IBM will provide the microprocessors that serve as the heart of Nintendo's new Wii U system, which will debut in 2012. The new Power Architecture-based microprocessor includes IBM's latest technology in an energy-saving silicon package. Nintendo's seventh generation console, Wii, features an IBM chip codenamed Broadway.  The older Nintendo GameCube utilizes the Gekko processor, also designed by IBM.

MISSION CRITICAL SYSTEMS

IBM has a worldwide reputation for transforming industries and its advanced mission critical systems for the following industries:

• Automating Rail Systems - Nearly all major U.S. railroads now used IBM technology to automate scheduling and accounting operations.  In 2010, helped Russian Railways move 1.3 billion passengers and freight more efficiently.
• Government Systems Infrastructure - IBM brings efficiency and modernization to the systems infrastructure for national and municipal governments to help them integrate real-time information and processes across many departments.
• Automating Aviation Industry Operations - Created the SABRE airline reservation system-- a precursor of everything from the ATM to e-commerce.
• Raising Healthcare Standards - Hospitals throughout the world now monitor temperature, blood and heart beat information using IBM health monitoring systems.    
• Smarter Energy and Water Systems - IBM helps governments and utilities analyze ways to increase power output of hydroelectric dams.  In 2009, helped implement the world’s first nationwide smart grid for Malta’s energy and water systems
• Reinventing Transportation - Many of the world's traffic signaling systems were developed by IBM.  Helped speed development of GM’s Chevrolet Volt electric vehicle with sophisticated design and simulation software.
• Upgrading The Retail Experience - IBM invented the UPC barcode system used by supermarkets and retailers everywhere throughout the world.
• Developing Banking Infrastructure - IBM created the first global settlement system for currency exchange, averaging $4 trillion a day, with the CLS Group, an industry consortium.  In 2008, introduced world’s first real-time securities settlement system for Mexico.

OPEN CLIENT OFFERING

In February 2007, IBM announced it launched its new software, called "Open Client Offering" which runs on Linux, Microsoft Windows and Apple's Mac OS X.   This product allows businesses to offer employees a choice of using the same software on Windows and its alternatives. This means that "Open Client Offering" is to cut costs of managing whether to use Linux or Apple relative to Windows.  There will be no necessity for companies to pay Microsoft for its licenses for operating systems since the operating systems will no longer rely on software which is Windows-based. One alternative to Microsoft's office document formats is the Open Document Format software, whose development IBM supports. It is going to be used for several tasks like: word processing, presentations, along with collaboration with Lotus Notes, instant messaging and blog tools as well as an Internet Explorer competitor – the Mozilla Firefox web browser. IBM plans to install Open Client on 5% of its desktop PCs. The Linux offering has been made available as the IBM Client for Smart Work product on the Ubuntu and Red Hat Enterprise Linux platforms.

GROWTH INITIATIVES

IBM has established long-term Road Map growth initiatives that they hope will result in incremental revenue growth of $20 billion by 2015.   These long-term growth initiatives include:

• Emerging Growth Markets - IBM's 2015 Road Map Objective includes a historic economic expansion in the fast growing emerging markets of the world, such as China, India, Russia and Brazil and the company is laying the foundation for a strong foothold in the continent of Africa.  The emerging market GDP growth rate—expected to be 5 percent through 2015—is more than double that of major markets.  Emerging growth markets revenue approaches 30 percent of IBM’s geographic revenue by 2015.  
• Cloud Computing - IBM has helped thousands of clients in areas as diverse as banking, healthcare and government build their own clouds or securely tap into IBM cloud-based business and infrastructure services. IBM manages millions of cloudbased transactions every day and provides cloud analytics services to its worldwide clients.  Cloud computing is a new, highly efficient model for consuming and delivering on demand IT-based services. Cloud revenue is expected to be $7 billion by 2015, of which $3 billion is incremental.
• Business Analytics - IBM helops enterprises manage and mine terabytes of potentially valuable data, and the key is advanced data analytics. IBM spotted this emerging need early, building the world’s leading analytics organization—with 7,800 expert consultants, the world’s premier nonacademic mathematics function and invested $14 billion to acquire 25 companies, broaden their capabilities.  To date, IBM scientists have received more than 500 analytics patents. Global data volumes are predicted to increase by 29 times over the next 10 years to 35 zettabytes.* (A zettabyte is a 1 followed by 21 zeros.). Business analytics revenue is  expected to be $16 billion by 2015.
• Smarter Planet - In 2008 and 2009, IBM implemented a bold initiative to make the world smarter, and in 2010, it deployed significant resources to capture the opportunity in key, high-growth industries where they maintain competitive advantage.  IBM also expanded its Smarter Cities initiative, targeting city infrastructure projects to integrate real-time information and processes across many city departments.  Major city infrastructure projects are now underway in Rio de Janeiro, Ho Chi Minh City, Shanghai, Seoul, Sydney, Helsinki, Amsterdam, Rotterdam, San Francisco and Washington, D.C.  Smarter Planet revenue is expected to be $10 billion by 2015.

ACQUISITIONS

CEO Samuel Palmisano is determined to make IBM a dominant player in business software services. IBM made almost 50 software acquisitions since 2006 in areas including data analysis,     e-commerce, supply chain management and computer security, said Mills. More than half of those have been in business-data analysis, where IBM says it has spent $14 billion.  The company expects such business analytics products to yield $16 billion in sales by 2015.  IBM had $99.9 billion in sales 2010.  Software, which had gross margins of 86.9 percent in 2010, is key to IBM’s growth plans. Here's a quick summary of their major acquisitions and prices paid between 2008 and 2011:

• Year 2011 - Completed 5 acquisitions to date, including Algorithmics Inc (risk management software) for $387 million, Platform Computing (clusters, grids and cloud management software).
• Year 2010 - Completed 17 acquisitions totalling $6.5 billion, including Netezza (data warehousing and analytics software) for $1.7 billion,  Clarity Systems (financial governance software) for $350 million, Unica Corporation (marketing planning software) for $480 million and Sterling Commerce (business software integration) for $1.4 million.
• Year 2009 - Completed six acquisitions totalling $1.5 billion, including SPSS (predictive analytics software) for $1.2 billion.  
• Year 2008 - Completed 15 acquisitions totalling $6.8 billion, including Cognos, Inc. (business intelligence software) for $5 billion and Telelogic AB (Product and project management and UML modeling software) for $885 million.

REVENUES BY SEGMENT 

IBM  segments revenues into five divisions:

• Global Technology Services - Provides outsourced IT infrastructure services and business process services, delivering business value through the company’s global scale, standardization and automation.
• Global Business Services - Provides professional services and application management services, delivering business value and innovation to clients through solutions which leverage industry and business-process expertise while integrating the industry-leading portfolio of IBM and strategic partners, to define the upper end of client-valued services.
• Software - Consists primarily of middleware and operating systems software. Middleware software enables clients to integrate systems, processes and applications across a standard software platform. IBM middleware is designed on open standards, making it easier to integrate disparate business applications, developed by different methods and implemented at different times. Operating systems are the software engines that run computers. Software capabilities includes: WebSphere software, information management software, Tivoli software, Lotus software, Rational software, business analytics (Cognos business intelligence software and SSPS predictive analytics software) software.
• Systems and Technology (Hardware) - Provides clients with business solutions requiring advanced computing power and storage capabilities. Approximately half of Systems and Technology’s server and storage sales transactions are through the company’s business partners; with the balance direct to end-user clients. In addition, Systems and Technology provides leading semiconductor technology, products and packaging solutions to clients and for IBM’s own advanced technology needs.
• Global Financing - Provides worldwide clients with financing to facilitate acquisition of IBM systems, software and services.  Global Financing invests in financing assets, leverages with debt and manages the associated risks with the objective of generating consistently strong returns on equity. 

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FINANCIALS YEARS ENDING DECEMBER 31, 2008, 2009 AND 2010

I am not very impressed with IBM's financial's.  Here's why:  

• Current Ratio - IBM's current ratio (current assets to current liabilities) for the year ending December 31, 2011 is not impressive (about 1:1).   Bankers normally would like to see a 1.5 to 2.00 current ratio.
• Financing Contracts - IBM is generating phenomenal returns from its Financing segment, but short-term financing and long-term financing contracts now constitute $26.8 billion combined or 23.6% of total assets. IBM's financing contracts are net of reserves for bad debts. It's reserves for bad debts are very low, but is risky given the state of the world economies.  Should IBM be in the banking business?   
• Borowed Debt - Short-term ($6.8 bil) and long-term debt ($21.8 bil) combined represent $28.6 billion or 31.7% of total liabilities, which is quite high.  If you take out deferred income (long-term support contracts) of $11.5 billion,  then the ratio baloons to 36.4%.  
• Debt-to-Equity - IBM's debt-to-equity ratio is 2.8.   This drops to 2.44% if you take out deferred income.  Most bankers would agree that 1.50 to 2.00 is an acceptable debt-to-equity ratio.  

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QUARTERLY EARNINGS - Q3 2010 THROUGH Q3 2011 

IBM has surpassed analysts earnings forecasts throughout most of 2011, and the market has rewarded the company by increasing the price of its stock by 28.61% since the beginning of the year. 

STOCK PRICE 

IBM has surpassed Hewlett-Packard is now the third most valuable technology company behind only #1 Apple Inc. ($361.4 billion) and #2 Microsoft ($224.9 billion) with a market capitalization of $222.46 billion as November 15, 2011.   The the year-to-date ending November 15, 2011, IBM's stock price has increased by 28.61% since the start of the year.  This exceeds the DJIA (+4.48%), NASDAQ (+1.26%) and the S&P (+0.01%).  IBM (NYSE:IBM) stock ended at 188.75 (up +1.40 or 0.75%) for the end of day's trading.  

Most stock analysts are not bullish on IBM stock, and many of them believe Mr. Buffet is acquiring IBM stock near its peak price, but Warren Buffet is not concerned with the stock price as he is future earnings potential.  IBM's growth strategy includes increasing its share of software business services through acquisitions (see above)  Software has much higher profit margins than hardware. IBM is also expanding its presence into fast growing emerging markets (China, Brazil, Russia, India and African continent) by capitalizing on its strengths in energy and power grid management solutions, government systems infrastructure, smarter energy and water systems, automated rail systems, traffic signaling systems, retail, ecommerce and banking software and hardware.

Warren evidently believes there is still room for IBM to grow revenues and earnings, and this will boost IBM's revenues, earnings and stock price even more.  Warren Buffet has overlooked IBM's relatively weak balance sheet, but it makes you wonder if there is something he knows that the general investing public does not.  Insider information, perhaps?  Warren Buffet has a track record of investing in solid companies (see above), then he holds the stock for the long-term, and he believes IBM has a great upside for 3 to 5 years down the line.

Courtesy of an article dated November 15, 2011 appearing in The Wall Street Journal, IBM Annual Report for the year ending December 31, 2011 and WikiPedia