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This is a clip from the exclusive "Hedgeye Investing Summit" interview between legendary short seller Jim Chanos of Kynikos Associates and Hedgeye CEO Keith McCullough on 10/15/20. To watch previous "Hedgeye Investing Summit" interviews, click here.
Below are key excerpts from Jim Chanos discussing his short position in IBM.
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Chanos: One of my favorite (and largest positions) is good ol’ IBM. It’s a really interesting story because it’s the ultimate value trap.
We were short this thing back in 2014-2015, when we realized there was no way Ginni Rometty could deliver on $20 per share; the real earnings were far lower than that, and they would have to reset expectations.
And that’s exactly what they did.
In 2015 and 2016, they fessed up that the earnings power of the company was actually $10, and the stock went from $200 to $120. We covered our short. Now let’s fast forward to today.
Chanos: Here’s the interesting part of the story. If you look at IBM’s “economic earnings,” they’re supposed to earn about $11 this year (2020), then $12 and $13 in 2021 and 2022, respectively. Here’s a simple equation:
Operating income + IP royalties – Interest (+ 22% taxes), the current number is about $6.40.
IBM has made the remaining $4 on tax credits, and all kinds of one-time items. The number is probably going to be $5 and change in 2021, and $4 and change in 2022.
$IBM normally trades at 10x earnings. It’s currently trading at greater than 10x expected estimates, but the reality is this company is earning HALF of what they’re saying.
The question is: How do you bridge that gap?
Chanos: IBM is the anti-cloud company.
As much as they claim they’re a cloud company, the cloud is killing them. Revenues decline every quarter YoY, and they’ve cut every cost they can.
They announced another Rometty-like split, where they’re going to spin off the crummy business and keep the good one.
The problem is, IBM is so structurally impaired, they’re spinning of the really bad business, just to keep the bad business.
This doesn’t solve anything. But, they’ll take a bunch of these charges, call them structural, and add them back to adjusted earnings. That’s how they’ll bridge the gap for the next 18 months or so.
This is just an accounting scam, and it’s a really obvious one.