One of the ways to profit from new technologies is by tagging along with mature players most affected by the change.
They are most motivated to maintain their dominance and so explore and incorporate the potential of these new processes. They have the wherewithal to invest in R&D, the resources to acquire startups to learn about the technology and with the leeway to make mistakes.
Here are two ways to apply that strategy to benefit from the emerging uses for blockchain technology. One company is a Fortune 500 giant and the other is a Canadian ETF that offers a mix of technology leaders with up and coming players.
IBM (NYSE: IBM)
International Business Machines is a master of adaptation and renewal.
What started as a merger of time-clock manufacturers in 1911 eventually brought us the mainframe computer in 1949 and the first PCs in the 1970s. IBM sold its PC business to Lenovo in 2005 to concentrate on consulting and software services.
Today the company is transforming again, moving into cloud computing, artificial intelligence, and Blockchain applications. The latter includes food safety as well as initiatives that speed shipments of goods and bypass slower international payments systems with simultaneous clearing and settlement options.
IBM’s plan is to integrate these processes into end-to-end services that help companies plan, build, and manage their information technology infrastructure. IT services accounted for 59% of IBM’s revenue in 2017 with another 31% coming from software development.
IBM operates in over 175 countries and gets 60% of its revenue outside of the U.S. It strives for innovation and had an R&D budget of $5.8 billion in 2018, which was approximately 7% of revenues.
R&D is a hidden asset because it creates a pipeline for new products and services. IBM was awarded more than 9,100 U.S. patents in 2018, more than any other company for the 26th consecutive year.
Recent developments: In October, 2018 IBM offered $34 billion to buy an open source software stalwart, Red Hat. It followed Microsoft’s smaller purchase in June of a similar software repository called GitHub.
Both companies want to bolster their cloud computing and storage abilities, where IBM has lagged the leaders. GitHub and Red Hat are leading developers of software for cloud-based systems, which enables customers to store and get access to files and programs on Internet servers.
Red Hat is IBM’s biggest acquisition. Given IBM’s market capitalization of $107 billion, it is a sizeable bet. It increases IBM’s long-term debt considerably and so IBM will pause share repurchases in 2020 and 2021.
Performance: IBM’s shares lost more than 25% of their value in 2018 as investors viewed its transformation as too slow. The Red Hat purchase towards the end of year was encouraging but coincided with a broader market downturn.
Since the New Year the shares are up 10% but remain near a two-year low.
The silver lining is that IBM’s dividend yield is 5.2% – the highest in more than 20 years. It raised its dividend in 2018 for the 23rd consecutive year, indicating a confidence in the future. The trailing price-to earnings ratio is 19.6.
In the three months to Sept. 30, IBM reported revenue of $18.8 billion, a 2.1% decline from a year earlier. Net income fell to $2.69 billion from $2.73 billion a year earlier. On a per-share basis, earnings rose to $2.94 from $2.92 due to a lower number of outstanding shares.
Outlook: IBM paid a 60% premium to market for Red Hat and is betting that after five years of slow growth it can turn itself around with the help of a bigger cloud footprint. The purchase gives Red Hat’s products the power of wider distribution through IBM’s sales staff.
Open source software is released under a license which lets users make changes and distribute the software. The initiative helps IBMs expand its growing presence in artificial intelligence (AI) and its Blockchain initiatives.
IBM expects Red Hat to add $3.2 billion to annual revenues. The deal is expected to close by the end of this year.
The hallmark of a good company is its ability to adapt to new circumstances. IBM has proved it can do that and what began as a gradual transformation five years ago is gathering momentum in 2019.
Harvest Portfolio Blockchain Technologies ETF (TSX:HBLK)
Harvest Portfolio Group launched Canada’s first Blockchain ETF in February 2018 and like all funds in the group, it has suffered as the Bitcoin fad has fallen out of favor. But the ETF holds many mature multinationals – including IBM – and many promising newcomers.
The fund was rebalanced in September and holds 21 stocks. Ten core large cap holdings include IBM, Microsoft, Visa, Intel, Accenture Plc, and SAP. They make up 49% of the ETF. Profitable emerging players account for the rest.
Performance: As of the time of writing, the unit price value was off 41.5% from its issue price of $10.
Key metrics: The fund had an average market capitalization of US$135 billion through Nov. 30. The dividend yield is 0.78%. The management fee is 0.65%.
For patient investors with some appetite for higher risk in part of their portfolio, this fund offers good upside and limited downside potential after a year-long selloff. The mature companies offer balance and the emerging players growth.
(This article first appeared in the Jan. 14, 2019 issue of the Internet Wealth Builder investment newsletter.)