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It’s no secret that International Business Machines (NYSE: IBM) needs to do something drastic to shake things up. Big Blue has been stuck in a prolonged turnaround that has yet to produce significant results.
But that’s not to say that the company isn’t doing a lot right during its turnaround phase, including divesting low-growth hardware businesses in exchange for higher-value businesses in new areas like the cloud, big data and security. And as a supplement to its internal initiatives, IBM is turning to mergers and acquisitions to buy additional growth.
The latest deal for IBM is a $2.6 billion takeover of data company Truven Health Analytics. The Truven takeover is another example of IBM’s major push into health care.
IBM badly needs a boost. Based on Wednesday’s closing price of $132.80, shares of the tech company are down 27% in the past two years. The S&P 500 index is up 4% in the same time, so it’s clear that IBM has woefully lagged the overall market. These declines are due to IBM’s long-running earnings erosion, and last quarter was no different.
On Jan. 19, IBM reported fourth-quarter earnings of $4.84 per share on an adjusted basis, on $22.06 billion of revenue. On a year-over-year basis, the results were once again poor. Revenue declined 9% as reported, while earnings per share fell 17% from 2014.
The good news is that IBM continues to generate strong free cash flow, which it can use to invest in M&A transactions like the Truven deal. Despite its declining revenue and earnings, the company is actually growing its free cash flow because of its turnaround strategy to branch out into higher-growth businesses. The company generated $13.1 billion of free cash flow in 2015, up $700 million from the previous year.
Why the Truven Takeover Makes Sense
Essentially, the Truven purchase combines two high-growth areas of technology – data and health care – which positions IBM very well as a future technological leader and helps break its reputation as a relic of the past.
Truven gathers a wide range of health-care-related data and performs analysis that allows customers – including payers and providers – to make better decisions and improve the overall quality of care. Truven brings more than 8,500 clients to IBM, including U.S. federal and state government agencies, employers, health plans, hospitals, clinicians and life sciences companies. In addition, Truven’s solutions help significantly reduce costs.
Bringing Truven on board should add to the capabilities of IBM’s major project, the supercomputer Watson. IBM already has launched the Watson Health unit and its Watson Health Cloud platform. The Truven deal will unlock additional capabilities for Watson in data and health care.
The deal represents a concerted effort on IBM’s part to expand its health-care reach. This will be the company’s fourth major health-care-related acquisition since it launched Watson Health. If and when the deal closes, IBM will have spent more than $4 billion on these endeavors.
And let’s not forget that financially, the deal makes sense for IBM as well. The company is highly profitable and remains a free cash flow machine. Plus, IBM ended 2015 with $8 billion in cash and another $5 billion in long-term investments on its balance sheet. It is a massive company with deep pockets, and all that cash is currently burning a hole in its pocket.
That’s why deploying some of its cash to make an acquisition that should provide significant growth over time is such a smart move. Investors have applauded the move, as IBM stock is up approximately 10% since news of the acquisition first broke. The optimism is understandable, as the Truven deal represents a potential catalyst for IBM to take a major lead in the emerging areas of data, the cloud and health care.
DISCLOSURE: Bob Ciura personally owns shares of IBM.
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