IBM Stock Valuation-PPT

International Business Machines:IBM

Presented by: Zahra Bajgiran, Mikhail Karasik, Jason Oakley,Kyle Thoresen, and Svetlana Zotikova

Company Overview

• Founded in 1911 through the merger of 3 companies• Old success: predominantly hardware-based up to 1990’s• New success: 84% of business is software and services• 410,830 Employees

Book Market

Total long term debt 21,932,000 21,932,000

Total shareholder

equity22,637,000 173,724,904

Total Capital 44,569,000 195,956,904

Weight of Debt 49% 11%

Weight of equity 51% 89%

Weight of Debt, Equity

• 1 - Market value• 2 - Book value

Weight of Debt, Equity

Market

Weight of Debt

Weight of Equity

Book

Weight of DebtWeight of Equity

Cost of Equity

CAPM model Beta R2 ResultKs = Krf+(RPm)*b 0.819 0.35 7.94%

Fama-French Model Resultks = kRF + bi(rM - rRF) + ci(rSMB) + di(rHML) 8.76%

Bond-Yield-plus-Market Risk Premium Bond Yield MRP ResultKce=Kd+RP 4.65 5 9.65%

Cost of Debt(1) Total interest expense paid/total debt based on balance sheet             Total debt:     26,100,000   Interest expense paid:   402,000              Kd: 0.0154023 1.54%   

(2) Annual report:                     Total debt:     26,100,000   Interest expense paid:   1,109,000              Kd: 4.25%     

WACCWACC = Wd*Kd (1-T)+We*Ke

• Tax rate: 25.9%• Wd: 11%• Kd: 4.65% (Bond Yield)• We: 89%• Ke: 7.94% (CAPM), 9.65% (BY+RPM), or 8.76% (FF)

WACC

Model WACC

CAPM 7.43%

Fama-French 8.16%

Bond – Yield—Plus—Market Risk Premium 8.96%

Sales Growth Rate

• 2004: 2.43% Growth• 2005: 2.37% Growth• 2006: 2.32% Growth• 2007: 2.27 % Growth• 2008: 2.22% Growth Forecasted Sales• 2009: 2.17% Growth• 2010: 2.12% Growth• 2011: 2.08% Growth• 2012: $109,649,000

COGS and R&D Ratios

1st Qtr 2010 2009 2008 2007 2006 2005

Total Revenue $22,857,000 $95,758,000 $103,630,000 $98,786,000 $91,424,000 $91,134,000

R & D $1,509,000 $5,820,000 $6,337,000 $6,153,000 $6,107,000 $5,842,000

COGS $12,880,000 $51,973,000 $57,969,000 $57,057,000 $53,129,000 $54,602,000

Percent of Total Revenue Average

R & D 6.60% 6.08% 6.12% 6.23% 6.68% 6.41% 6.35%

COGS 56.35% 54.28% 55.94% 57.76% 58.11% 59.91% 57.06%

Forecasting: AFN’s2010 Pass

Additional Funds Needed (12,442,178) (141,843) (1,617) (18) Short / Current Long Term Debt (1,986,935) (22,651) (258) (3) Long Term Debt (10,455,243) (119,191) (1,359) (15) Additional Interest (191,638) (2,185) (25) (0)

2011 Pass Additional Funds Needed (12,883,277) (146,871) (1,674) (19) Short / Current Long Term Debt (2,057,375) (23,454) (267) (3) Long Term Debt (10,825,902) (123,417) (1,407) (16) Additional Interest (198,432) (2,262) (26) (0)

2012 Pass Additional Funds Needed (13,329,446) (5,501) (0) N/A Short / Current Long Term Debt (77,058) (0) N/A N/A Long Term Debt (405,481) (0) N/A N/A Additional Short Term Investment 12,846,906 5,501 (0) N/A Additional Interest (7,432) (0) N/A N/A

Free Cash Flow Growth• FCF = NOPAT- Investment in Operating Capital

2012 2011 2010 2009 2008

13,334,928 13,037,325 12,739,721 16,483,544 21,872,607

2009.5 2010 2010.5 2011 2011.5 2012 2012.512400000

12500000

12600000

12700000

12800000

12900000

13000000

13100000

13200000

13300000

13400000 2010 12,739,319

2011 13,036,797 2.34%

2012 13,334,272 2.28%

2013 13,631,753 2.23%

2014 13,929,231 2.18%

2015 14,226,709 2.14%

2016 14,524,187 2.09%

Intrinsic Value of Operation• Horizon value = FCF2012*(1+g)

WACC- g

• Operation Value = PV of expected FCFWACC 8.56%

Average growth rate 2.23%

Horizon value 215,384,326

Adjusted FCF 228,719,254 13,037,325 12,739,721

Intrinsic Value of Operation $201,565,552

Corporate Value & MVA• Total Value = Vop + Vnon-operating assets

• MVA = Market Value of Stock - Total Equity

Operating value 201,565,552

Non-operating Value 1,791,000

Total Corporation Value $203,356,552

Intrinsic Value of Stock $133.56

Actual Stock Price 2009 $130.90

Intrinsic MVA $154,619,552

Intrinsic Equity Value & Stock Price

1. Total corporation value $203,356,5522. Less: Value of debt $26,100,000 Preferred stock $03. Intrinsic value of equity $177,256,5524. Divide by number of shares 1,327,1575. Intrinsic value per share $133.56

Actual stock price on 12/31/09 $130.90

MMM Approach

Computer Software/Services = 84% EBIT multiple = 11.35

Computers/Peripherals = 16% EBIT multiple = 10.28

EBIT Multiple for IBM = 11.18 (Weighted average)

Intrinsic Value of Stock Per Share = $136.50

Actual stock price on 12/31/09 = $130.90

ROIC and EVA Analysis

ROIC = NOPAT / Operating Capital = 18.20%

WACC = 8.56%

ROIC - WACC = 9.64% (Firm is adding value)

EVA = Operating Capital * (ROIC-WACC) = 7,268,268

IBM Firm Value• WACC influences firm value• Intrinsic value of stock ~ (1 / WACC ) n

• Industry has higher cost of debt, but similar cost of equity

Industry Name Beta Cost of Equity WACC Cost of Debt Weight of equity

Weight of Debt Tax Rate After-tax Cost of

Debt

Computer Software/Services 1.02 8.94% 8.84% 7.84% 94.68% 5.32% 10.12% 7.05%

Computers/Peripherals 1.29 10.28% 9.97% 7.84% 90.14% 9.86% 8.65% 7.16%Industry (Weighted

Average)* 1.06 9.15% 9.02% 7.84% 93.96% 6.04% 9.88% 7.07%

CAPM 0.82 7.94% 7.43% 4.65% 88.79% 11.21% 25.98% 3.44%

Fama French N/A 8.76% 8.16% 4.65% 88.79% 11.21% 25.98% 3.44%

Bond Yield + Risk Premium N/A 9.65% 8.96% 4.65% 88.79% 11.21% 25.98% 3.44%

Average (FF) and (BY + RP) N/A 9.21% 8.56% 4.65% 88.79% 11.21% 25.98% 3.44%

IBM Firm Value• Dependent on method used to determine cost of equity

• Some methods were remarkably close

• Average of FF and Bond Yield + Risk Premium showed best correlation

CAPM FF Bond Yield +

Risk PremiumAverage (FF) and

(BY + RP) Industry MMM

Intrinsic Value of Stock($/sh) 166.50 143.69 124.62 133.56 123.31 136.50

Actual Stock Price End of Year 2009 ($/sh) 130.90 130.90 130.90 130.90 130.90 130.9

Was the Stock Overvalued or Undervalued? under under over under over under

Scenario Analysis

• FCF growth positive but less than inflation

• IBM is too big to have a large growth rate

• Stock probably fairly priced

Scenario Analysis (WACC = average of FF and BY + RP)

Average growth rate of FCF (g) -1.00% 2.10% 2.37% 3.00%

Intrinsic Value of Equity 116,841,271 173,724,986 181,157,046 201,982,962

Total Numbers of Common Stocks Out. 1,327,157,410 1,327,157,410 1,327,157,410 1,327,157,410

Intrinsic Value of Stock Per Share 88.04 130.90 136.50 152.19

Actual Stock Price at the End of Y2009 130.90 130.90 130.90 130.90

Was the Stock Overvalued or Undervalued?

Stock overvalued Fair Stock

undervaluedStock

undervalued

MMM

How to Increase Equity

• Reduce WACC (difficult)

• Incentivize management to grow FCF

• Limit dividend growth (eventually)

• In the end, company strategy plays a crucial role

Strategy Shift

1950 1960 1970 1980 1990 2000 2010 2020

-10,000

-5,000

0

5,000

10,000

15,000

YearNet

Inco

me

($ m

illio

ns)

Software/Services emphasis

Hardware emphasis

~$130 / share (today)

~$10.50 / share (1993)

~$31 / share (1985)

Thank you!