Why I Sold IBM

Over the past few quarters, I’ve become increasingly uncomfortable with my investment in IBM (IBM). After a lot of thought, I decided that it made sense to sell my entire position (which I did on Wednesday). I wanted to share some of the considerations that led me to this conclusion.

Weak results

Over the past few years, the results from IBM’s “Strategic Imperatives” have been pretty good. At the same time, the results for IBM’s legacy businesses have gone from bad (mid-single digit revenue declines) to worse (double-digit revenue declines in recent quarters). This has led to a consistent (albeit slow) decline in IBM’s revenues despite help from a number of acquisitions.

Many investors (myself included) will point to the fact that at some point, the decline in the legacy businesses will be more than offset by growth in “Strategic Imperatives” – assuming the current trends hold. Personally, I’m not as comfortable with that assumption as I was a few years ago. As opposed to a company like Microsoft (MSFT), I’m not convinced IBM has turned the corner. I continue to see data points that suggest the opposite may be true (the results of a recent Goldman Sachs IT Survey, published in mid-December, is a notable example).

Over the past five years, IBM’s earnings power has not improved; I don’t have a high degree of confidence that this will change over the next five years.


Warren Buffett (Trades, Portfolio)

I discussed the relevance of Warren Buffett (Trades, Portfolio)’s involvement at IBM during my most recent year-end portfolio review:

•     I don’t take comfort in much of what I read about the continued success of emerging competitors like Amazon (AMZN); this is exacerbated by the fact that I do not have the industry expertise required to understand the potential developments in this business over the next five-plus years.
•     In the past, I’ve accepted that reality by leaning on two crutches: one, the valuation, and two, Warren Buffett’s continued ownership of the stock. The first point is less compelling if the stock continues to climb; the second point isn’t the way I prefer to operate either, regardless of how cheap the stock appears. That’s a long-winded way of saying that I’m likely to sell shares of IBM in 2017; I think my time and efforts could be better spent elsewhere.

As most readers likely know, Warren Buffett (Trades, Portfolio) has been a major seller of IBM shares as of late. At the end of the most recent quarter, Berkshire Hathaway owned roughly 37 million shares of IBM. By comparison, Berkshire Hathaway held more than 81 million shares of IBM at the end of 2016. The numbers speak for themselves.

I can live with the fact that Warren Buffett (Trades, Portfolio) – the investor – is selling the stock.

What really concerns me about this move is the knowledge that Warren Buffett (Trades, Portfolio) brings to the table as the CEO of Berkshire Hathaway (with insight into the decision-making of dozens of operating businesses). Consider what Buffett said when he initiated his position in IBM:

“We went around to all of our companies to see how their IT departments functioned and why they made the decisions they made. And I just came away with a different view of the position that IBM holds within IT departments and why they hold it and the stickiness and a whole bunch of things… I don't want to push the analogy too far because it could be pushed too far, but we work with a given auditor, we work with a given law firm. That doesn't mean we're happy every minute of every day about everything they do but it is a big deal for a big company to change auditors, change law firms. We've got dozens and dozens of IT departments at Berkshire. I don't know how they run. I mean, but we went around and asked them and you find out that they very much get working hand in glove with suppliers. That doesn't mean things won't change but it does mean that there's a lot of continuity to it. And then I think as you go around the world, IBM, in the most recent quarter, reported double-digit gains in 40 countries. Now, I would imagine if you're in some country around the world and you're developing your IT department, you're probably going to feel more comfortable with IBM than with many companies.”

If IBM’s position isn’t quite as sticky as once thought, that’s a major concern for investors. Over the past few years, I've seen numerous data points that indicate this is exactly what’s happening (as an example, take a look at the growing list of enterprise customers that are moving to AWS).

Warren had another unique opportunity to assess IBM’s value proposition to clients: as he noted during a CNBC interview in early 2016, GECIO was involved in a “fairly elaborate experiment” with Watson that they had been working on “for quite a while.” When Warren was asked about Watson again in May, he added that when “other very smart people have been given some time to work on other products… you have to worry about somebody jumping the utility of something like [Watson].”

Over time, Warren's words and his actions suggest that he has become less certain about IBM’s future. Considering where he’s coming from, that conclusion carries a lot of weight in my book.

Conclusion

Despite owning IBM for a few years, I still do not have a strong sense for what this business will look like five to ten years down the road. I used Warren Buffett (Trades, Portfolio)'s vote of confidence as a crutch on this investment – and if he’s selling, I should do the same. Unlike my other holdings, I have not dealt with IBM’s price swings with equanimity. In my experience, that’s a good sign to head for the exits and focus my efforts elsewhere (no matter how delayed that conclusion may be).

If I didn’t own IBM, I wouldn’t buy it today. Sticking with the stock solely because I thought it made sense previously (and to avoid admitting “defeat”) would be another error.