Can IBM Make a "Quantum" Leap?

Published October 05, 2017
Motley Fool

We've all heard the narrative by now: IBM (NYSE: IBM) is in terminal decline, having fallen prey to younger, leaner companies such as Amazon. And even former cheerleader Warren Buffett is ditching the stock.

To this point, IBM's revenue has been declining for 21 straight quarters, and many of the company's high-touch, high-cost offerings have become increasingly commoditized by cloud computing. While the Jeopardy-winning Watson product was supposed to be the company's next big thing, it's not showing up (yet, at least) in the company's revenues, and reports on some Watson pilot programs have not been entirely positive.

However, while IBM may be hanging on to declining (but profitable) businesses and paddling hard to catch up in cloud computing, the company is also investing research dollars toward the next big thing. Here are a few moves IBM is making with an eye on the next century, not the next quarter.

Quantum leaps

IBM researchers recently put out a paper describing a breakthrough in their quantum-computing research lab. While a traditional computer uses ones and zeroes, or "bits," to store information, quantum computing uses "qubits" in which a one and a zero are present at the same time in a superposition state. That enables a quantum computer to process much more information than a traditional computer or even a supercomputer. IBM is pioneering research in the field, although other tech giants like Google and Microsoft are also experimenting with quantum computing.

In a recent paper, IBM researchers were able to write an algorithm that harnesses quantum computing's power to "derive the lowest energy state of a molecule of beryllium hydride."

While that may not seem like much, it's important because deriving an energy state of a large molecule allows researchers to understand complex chemical reactions. This research may pave the way for the development of new pharmaceutical drugs and other advanced materials.

IBM invests in MIT

Another major recent announcement was IBM's investment of $240 million over a 10-year period to establish the MIT-IBM Watson AI Lab, where IBM researchers and students will work on next-generation artificial intelligence solutions. It's unclear who will own the intellectual property of the venture, although I would imagine it would be shared among students and the company in some way.

According to IBM's vice president of artificial intelligence Dario Gil, "The core mission of [the] joint lab is to bring together MIT scientists and IBM ... to shape the future of AI and push the frontiers of science."

What's the impact?

These moves clearly show that 107-year-old IBM is looking to get younger by focusing on new technologies that will impact the next generation. Skeptics may say (and would not be entirely wrong) that IBM must do this because it missed out on the current generation's leading technologies, or at least missed out becoming a leader with strong franchises.

However, I think investors should be encouraged. First, the cost impacts of these investments are rather low. The $240 million the company is setting aside to partner with MIT over 10 years is a negligible portion of IBM's $6 billion annual research-and-development budget. Moreover, working on exciting new technologies is a good way to attract young talent, and IBM has more competition than ever for engineers and developers these days. A good way to get a leg up on the competition, of course, is to establish relationships with talented individuals while they are still in college or graduate school.

Finally, there could (eventually) be a significant business payoff. Shareholders, of course, should not expect anything this quarter or even in the next few years -- but at the very least, new research should bolster IBM's leading patent trove. In 2016, IBM's "intellectual property and custom development income," from patent sales and licensing, amounted to $1.6 billion, or a significant 13% of the company's operating income.

Moreover, it's likely IBM will acquire shares in the start-ups that come out of the MIT venture, and these start-ups could one day become successful companies in their own right.

A reason to buy?

It's tough to judge the cross-currents of IBM's struggling legacy businesses along with the prospects of potential technology breakthroughs. To me, IBM remains one of the most interesting companies in the market, as it trades at only 11.8 times earnings and has a dividend over 4%. Yet it faces more uncertainty than a typical large-cap dividend stock.

At this valuation, IBM is weirdly both attractive to income- and growth-oriented investors. If its to live up to expectations for either set of investors, it needs strong footholds in the next age of tech, and these initiatives certainly help.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors; LinkedIn is owned by Microsoft. Billy Duberstein owns shares of GOOG, AMZN, IBM, and MSFT. The Motley Fool owns shares of and recommends GOOGL, GOOG, and AMZN. The Motley Fool has a disclosure policy.