Morgan Stanley Upgrades IBM, Says Transformation Is Underappreciated

• International Business Machines Corp. (NYSE: IBM) shares appreciated 1.64 percent over the past five days, while rising almost 3 percent in pre-market trade on Thursday.
• Morgan Stanley’s Katy L. Huberty has upgraded the rating on the company to Overweight, while raising the price target from $135 to $140.
• Huberty believes that the company’s transformation into a more cloud and analytics focused business is currently underappreciated, although new disclosures could build confidence.

Analyst Katy Huberty believes that IBM’s share price does not reflect the ongoing transformation, with Strategic Imperatives, including cloud, data and engagement, now accounting for 35 percent of the revenue and growing 26 percent on a constant currency basis in 2015.

“We expect the valuation disconnect to correct with new disclosures, stabilizing revenue trends this year, and improving FCF,” Huberty said.

In addition, the analyst believes that the company’s revenue growth is bottoming, with analysis suggesting that despite the continued 15 percent annual decline in the core IBM revenue and weakening growth of Strategic Imperatives after the 2015 product cycle, the company’s constant currency revenue declined bottomed at -4 percent in 2015.

“Importantly, we expect flat revenue in 2018 and a return to growth in 2019 as Strategic Imperatives surpass 50 percent of revenue. We believe the risk to these estimates is to the upside in light of a faster shift of investment dollars to growth areas in recent quarters,” according to the Morgan Stanley report.

These investments have positioned IBM to benefit from a structural shift to application oriented solutions, from infrastructure based ones.

“We believe IBM is coming up on renewals of large customer enterprise license agreements in late 2016 which could further improve deferred income, and therefore FCF trajectory,” the report added.