IBM Contracts Most Expensive Since 2005 as Sales Slump

Options (IBM) traders are paying the most since 2005 to protect against stock swings in International Business Machines Corp. relative to its peers on concern profit will trail analyst estimates for a second quarter as sales drop.

Implied volatility for contracts with an exercise price closest to the company’s stock was 1.44 times the Technology Select Sector SPDR Fund, the highest since September 2005, according to three-month data compiled by Bloomberg. IBM shares have slumped 8.6 percent over the past three months, the most in the Dow Jones Industrial Average.

While Chief Executive Officer Ginni Rometty has pushed the company into faster-growing markets like data analysis and repurchased shares, IBM is contending with sluggish demand for hardware and consulting work. IBM missed earnings estimates in April for the first time in eight years and will probably say today that second-quarter revenue fell 2 percent, based on analysts’ estimates tracked by Bloomberg.

“You’ve got to meet these earnings numbers, otherwise you get penalized,” Edward Painvin, chief investment officer of Chase Investment Counsel Corp., said by phone from Charlottesville, Virginia, on July 15. His firm oversees $500 million and doesn’t own IBM shares. “It’s difficult to do for a name of this size with very, very little top line growth.”

Photographer: Scott Eells/Bloomberg

IBM missed earnings estimates in April for the first time in eight years and will probably say today that second-quarter revenue fell 2 percent, based on analysts’ estimates tracked by Bloomberg. Close

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Photographer: Scott Eells/Bloomberg

IBM missed earnings estimates in April for the first time in eight years and will probably say today that second-quarter revenue fell 2 percent, based on analysts’ estimates tracked by Bloomberg.

Implied volatility for three-month IBM contracts has surged 51 percent from a January low, according to data compiled by Bloomberg. The options gauge for the technology fund has risen 2.7 percent during the same period.

Mike Fay, a spokesman for Armonk, New York-based IBM, declined to discuss the company’s earnings ahead of the report.

Earnings Season

IBM, the largest provider of computer services, may report after the market close that sales during the three months ended June slid 2 percent to $25.3 billion, according to the average estimate from 20 analysts in a Bloomberg survey. Excluding some items, profit was probably $3.78 a share, an 8 percent increase after an expansion of more than 10 percent from 2010 to 2012.

The results may include costs tied to a $1 billion restructuring plan that involved cutting thousands of employees. The company said in April that asset sales later in the year would help offset the cost. At the time, IBM was in talks to sell parts of its server division to Lenovo Group Ltd., according to people familiar with the discussions. The negotiations broke down in early May due to disagreements over price, one person said.

Without a large divestiture, IBM doesn’t have a gain to make up for the restructuring charge, Ben Reitzes, an analyst for Barclays Plc, said in a July 1 note to investors.

‘Honeymoon Over’

The options market is implying IBM will move 4.8 percent after the release, compared with an average post-result change of 3.7 percent since 2006, data compiled by Bloomberg show.

Investors will use the latest earnings to judge the progress of Rometty, who took charge at the beginning of last year, said Josh Olson, an analyst with Edward Jones & Co. She has shaken up management of IBM’s struggling hardware division, spent $2 billion on a cloud-computing business and cut jobs globally in a bid to refocus the company.

“It is a key quarter,” Olson said. “The honeymoon year is over. We’re 18 months into her leadership now, and the days of giving her the benefit of the doubt are behind us.”

The slowdown in developing countries like China, which accounted for 80 percent of IBM’s revenue expansion from 2010 to 2012, is a threat to the company’s growth, according to Bill Shope, an analyst with Goldman Sachs Group Inc. in New York. The stock was up 1.2 percent this year through yesterday, trailing an 11 percent rally in the Technology Select Sector SPDR Fund.

Stagnation Period

“IBM’s growth markets have a reached a period of stagnation,” Shope wrote in a July 9 note, cutting the stock’s rating to neutral from buy. “The company appears to be going through a challenging period that may limit operational earnings upside and produce more quarterly volatility than investors have been accustomed to.”

A broader technology slump may make it tough for IBM to deliver on its goals, said Ivan Feinseth, chief investment officer at Tigress Financial Partners LLC in New York. Accenture Plc (ACN), the world’s largest technology-consulting company after IBM, last month forecast sales that missed analysts’ estimates.

“There are factors way beyond their control that make it very difficult,” Feinseth said. “There’s no really compelling driver to own the stock right now.”

Management Change

After April’s earnings miss, IBM reassigned Rod Adkins, the head of its hardware division, to a new role, replacing him with Tom Rosamilia, who had been overseeing corporate strategy.

Last month, IBM agreed to buy SoftLayer Technologies Inc., a cloud-computing storage provider that will help the company compete with Amazon.com Inc. The price was about $2 billion, according to a person familiar with the matter.

Acquisitions last year totaled $3.7 billion for 11 companies, including $1.3 billion for Kenexa Corp., a company that uses social networking to help businesses handle human resources and recruiting. IBM announced $5 billion of stock buybacks and boosted its quarterly dividend by 12 percent to 95 cents a share in April.

“They’re well positioned in the long term,” Kim Forrest, a Pittsburgh-based analyst at Fort Pitt Capital Group Inc., which oversees $1.3 billion including IBM shares, said in a July 11 phone interview. “They have concentrated their efforts in high-margin businesses. Their focus on big data is a great strategy for them to get the IT consumer’s attention. And I really do believe they can deliver on these products.”

IBM Valuations

The stock slump in the past three months has pushed IBM’s valuations close to the lowest level since 2010. The shares traded at 12.5 times reported earnings in the past 12 months, compared with the multiple of 16.1 for technology companies in the Standard & Poor’s 500 Index, according to data compiled by Bloomberg.

The Chicago Board Options Exchange Volatility Index (VIX), known as the VIX, fell 2.5 percent to 14.06 at 11:35 a.m. in New York today. Its European counterpart, the VStoxx Index, a measure of Euro Stoxx 50 Index option prices, slid 3.9 percent to 18.49.

Options traders have boosted ownership of bearish contracts. The ratio of outstanding puts relative to calls rose 18 percent from its 2013 low in April to 0.85-to-1 yesterday, data compiled by Bloomberg show.

“The market is trying to come to terms with whether this was a one-time miss or a more serious longer term threat to the business model,” Alec Levine, an equity-derivatives strategist at Newedge Group SA in New York, said in an interview last week. “There is real concern and the options trading reflects that concern.”

To contact the reporters on this story: Lu Wang in New York at lwang8@bloomberg.net; Sarah Frier in New York at sfrier1@bloomberg.net

To contact the editor responsible for this story: Lynn Thomasson at lthomasson@bloomberg.net; Nick Turner at nturner7@bloomberg.net

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