International Business Machines Corp. (IBM) is on a determined path to get its earnings per share to $20.00 by 2015 at almost any cost. We have thought that the cost for this goal is too high. Now it turns out that a short-selling exchange traded fund (ETF) has grown so concerned that IBM has become the fund's number-one short sale position. Its reasons are beyond just that IBM's revenue growth effectively has stalled and beyond how management treats the company internally. Portfolio managers John Del Vecchio and Brad Lamensdorf manage the short-only portfolio of actively managed stocks for the Ranger Equity Bear ETF (HDGE) under the AdvisorShares ETF family, and they have some concerns to share.
24/7 Wall St. had a chance to discuss why this short-selling team is betting so heavily against IBM with portfolio manager Lamensdorf. This short-only ETF has almost $200 million in assets under management.
We might not have given this much thought if IBM was just a random company with declining metrics. However, IBM is more than just a typical Dow Jones Industrial Average (DJIA) component. It has the most heavy weighting of any of the 30 DJIA stocks, coming in at just over 9.7% of the entire DJIA, for what is nearly three times a benchmark weighting of 3.33% (1 of 30 on average).
Lamensdorf's points were based on actual fundamentals on the balance sheet and on the income statements. In fact, IBM's current accounting grade is considered a D on the Del Vecchio Earnings Quality Index. He said, "We haven't liked IBM fundamentally for some time. The earnings quality is one serious issue, but we are seeing some technical deterioration in the stock as well. It is our largest short position with a 5.5% weighting, about twice the weighting of an average short-sale position in the ETF."
The management team's ongoing concerns are far beyond our own concerns over management's strategy and employee morale. Lamensdorf signaled to us that other metrics are coincidental and that the D grade for IBM's accounting today is based on key financial metrics that make up the grading system. They do not try to throw any subjective base that changes what the accounting metrics generate.
Lamensdorf thinks that IBM is playing games with earnings quality via the ongoing stock buybacks. His biggest concern was surprising to us because IBM is trying to get more and more cloud business. Lamensdorf said, "IBM is likely to face pressure from outside cloud computing against its core services because so many aspects of their basic services are now being offered by other cloud services providers." Unfortunately, this sounded like a classic business dilemma, where there may be more threat to the core business than there is opportunity to profit from it.
Lamensdorf did admit that IBM actually does screen out as a cheap stock on traditional metrics. He also pointed out that it has some bond-like aspects that had previously attracted shareholders. IBM's D accounting grade looks beyond these strengths. He added that IBM's acquisitions have been at expensive multiples, and the risk is that IBM's international operations are so large that the currency effects will drag on earnings as the dollar strengthens.
Three other current short sale ideas, which are active short sales in the Ranger Equity Bear ETF (HDGE), were mentioned as well. We have shown the stocks, as well as the team's comments given to us on each short-sale candidate.
- Texas Industries Inc. (TXI) is a short sale of theirs. They said, "This cement maker has negative cash flow and weak earnings."
- National Instruments Corp. (NATI) is another short sale. The team said, "Its missed earnings estimates, has a high P/E and margins are slipping significantly."
- Terex Corp. (TEX) is the team's last short sale pick, because "It is heavily leveraged, missed its earnings recently and more trouble is ahead. Much of its crane business is poorly positioned in Asia and other businesses are slowing."
IBM shares recently traded at $196.01, against a 52-week trading range of $184.78 to $215.90. Also note that the most recent IBM short interest reading of 18.25 million shares was the second highest of 2013. The team managing the Ranger Equity Bear ETF thinks that the short sellers are going to be rewarded here.