Back in 2011, Warren Buffett’s Berkshire Hathaway made headlines with its unexpected 5.4% stake purchase in IBM, marking a departure from Buffett’s traditional avoidance of tech stocks.
However, as IBM’s stock price dwindled in the following years, Berkshire decided to liquidate its position. A hypothetical investment of $1,000 in IBM in 2011 would now be worth $765, significantly underperforming the S&P 500 index fund.
In this article, we explore why Buffett initially invested in IBM, how the company fell behind in the tech race, and its plans for a comeback.
Buffett’s Attraction: IBM’s Potential and Value
IBM caught Warren Buffett’s attention due to then-CEO Sam Palmisano’s ambitious goal of doubling the company’s annual earnings per share (EPS) from $10.01 in 2009 to $20 by 2015.
IBM’s low valuation, trading at just 13 times its 2011 earnings, seemed attractive to Buffett. Moreover, the company’s reputation for providing essential IT support to enterprise customers made it appear resilient and “sticky” in the industry.
The Tech Curve and IBM’s Missteps
While IBM’s business was indeed sticky, it struggled to keep up with the rapidly evolving tech landscape. The company’s myopic focus on short-term profits led to aggressive cost-cutting and neglect of the emerging cloud infrastructure platform market.
IBM underestimated the potential of cloud giants like Amazon, Microsoft, and Google, which led to the migration of many enterprise customers to their cloud services. IBM’s lack of investment in the cloud and its failure to adapt caused it to fall behind, losing market share and revenue.
IBM’s Attempted Fixes and Challenges
IBM’s subsequent CEO, Ginni Rometty, recognized the threat posed by cloud infrastructure platforms and acquired SoftLayer in 2013. However, SoftLayer’s offerings proved inferior to those of its competitors, hampering IBM’s ability to catch up. Internal conflicts further impeded the necessary upgrades and development of competitive features.
Additionally, IBM continued to divest from weaker businesses while relying on stock buybacks, which failed to offset declining revenues. The company’s failure to reach its EPS target of $20 by 2015 revealed the extent of its struggles.
Revival Strategies under Arvind Krishna
With Arvind Krishna taking the helm in 2020, IBM embarked on a three-pronged approach to revive the company. First, it spun off its slow-growth managed infrastructure services into Kyndryl in 2021.
Second, IBM aims to expand its acquisition of Red Hat, the open-source software giant, by integrating more AI and hybrid cloud services. This strategic niche approach positions IBM to capitalize on the growing AI and cloud markets without direct competition against established players.
Finally, the company plans to streamline operations through job cuts and replace some positions with AI services.
Path to Redemption
IBM’s efforts have shown promising signs. In 2022, the company witnessed a 6% increase in revenue and a 15% rise in adjusted EPS. Analysts project a 3% growth in both revenue and adjusted EPS for 2023. Looking ahead to 2024, expectations are set at a 4% increase in revenue and a 6% rise in adjusted EPS.
While these estimates should be viewed with caution, they indicate a potential turnaround for the once-dominant tech giant.
