IBM: Reflating the Corporate Bubble, GE-Style 18 comments
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On Tuesday, IBM announced a $3b share-buyback and 10% increase to their dividend, despite a 10% decrease in revenue in Q1. Judging by moves like this, the concept of deleveraging doesn't seem to have taken hold with many big companies. Unfortunately, it doesn't look like financial wizardry is going away in the near future.
Using Debt to fund Buybacks and Dividends
It was just last October that IBM raised $4 billion from bond sales. They paid a fairly high price too, with yields ranging from 6.5% for the 5 year bond, to 8% for the 30 year bond (details here). Now they announce a $3 billion share repurchase, and a boost to the dividend?
Layoffs Too?
Official numbers are hard to find, but it appears that IBM has laid off up to 10,000 workers in North America this year. Public companies have a responsibility to shareholders to maximize ROI. At times that requires getting rid of some dead wood. But is it really prudent to lay off 10% of your U.S. workforce, while ramping up spending on share buybacks and dividends? That must be horrible for employee morale and loyalty.
I can’t think of a better way to describe IBM’s strategy here than “jacking up the dividend, then doing a big ol’ share buyback to lure in longs and scare off shorts, resulting in a short-term pop in our stock. Yes, we have a bunch of liabilities that we should probably pay off first, but we’ll deal with that later“. Hmm, that doesn’t exactly roll off the tongue. Maybe if The Treasury Dept was in charge of naming it, they’d give us a catchy acronym like JUDDBSBLLSSRSTPOSYWHBL....
Will the buybacks, layoffs, and dividends that IBM purchased be worth the cost? I’m skeptical to say the least. They may succeed in temporarily juicing the stock, which is probably what management wants to happen. That allows for bonuses and profits from employee stock options. But will these moves be good for IBM 10 years down the road? I highly doubt it.
Sketchy moves like this buyback should discourage investors from buying IBM. Wall St, however, was predictably impressed. The logic must have been along these lines, “yield good, money good, earnings good. buy ibm.” I haven't seen any concern about their balance sheet mentioned.There are so many better companies to own other than IBM, I don’t get it. Among other tech companies, I’d take Apple (AAPL) over IBM any day, even at current valuations.
The Flawed Rational of Share Buybacks
Share buybacks are touted as a great way to return value to shareholders. They do increase earnings per-share, as the total # of outstanding shares decreases. But in reality, buybacks are often just poorly-timed efforts to support a stock price. They’re also a distraction to management, who arguably have no business engaging in what is basically the day-trading of their own stock. Unfortunately, many boards of directors have the tendency of insta-approving reckless moves like this.
I think of buybacks as debt-fueled orgies that are usually accompanied by unsustainable dividends. Buybacks are the worse of the two. But borrowing money, so you can pay it out in dividends, is also a pretty stupid thing to do.
GE is arguably the worst offender when it comes to this type of scheme. In their day, GE's buybacks make IBM’s announcement look miniscule. From 1994 to 2004, GE bought back 1.1 billion of their own shares, at a huge premium to their price yesterday. At the same time, they piled up debt, taking advantage of their AAA rating.
During the 10 year period up leading up to 2004, GE spent ~$75 billion on dividends and buybacks. Unfortunately I couldn’t find reliable information on how much they’ve spent since then. But I’m pretty sure the total would be staggering. This year alone, they were on track to pay out ~$13b in dividends, until they had to reluctantly slash the payout.
The Good Times Can’t Last Forever
The buybacks propped GE’s stock up for a while, and the dividends kept investors happy. But GE is now feeling the hangover from their binge. They currently have $504b in long-term debt, and seem reliant on the government’s generosity to roll-over their short-term paper. They have massive exposure to the commercial-real-estate market, credit cards, and other vulnerable pieces of our economy. It’s a shame that a great American institution like GE has been reduced to this. But it’ll be a much bigger shame if taxpayers end up footing the bill for their risky loans.
I got a little off track there, sorry about that. Sometimes it’s hard to stop ranting about GE. Back to IBM’s balance sheet. It certainly isn’t as bad as GE’s, but it ain’t pretty either. The announcement Tuesday may give IBM shares a temporary boost and scare off potential shorts. But in the long run it will degrade their balance sheet further, and reinforce the cycle of debt. Here are some highlights from their Q1 2009 balance sheet:
- Debt/equity ratio of 2.28x. That’s quite high, especially for a mature tech company
- $18b in unfunded pension liabilities, plus $11.4b in “other unfunded liabilities”
- $9.8b in short-term debt, plus another $21.1b in long-term debt
- $12.2b in cash, $1 million in short-term investments
- $37b in total current liabilities, and $44b in current assets
The last bullet-point is the most concerning. It meants that IBM's current ratio is only 1.18x, which indicates that their short-term liquidity situation isn't great. In our current economic environment, why are they scraping by with minimal liquidity, and simultaneously increasing the dividend and instituting a $3b share-buyback? They could be putting that money towards paying off their substantial total debt of $30.9b. Instead, it seems they plan to keep re-financing and rolling debt over for eternity. Who knows, they might be forced to sell back those repurchased shares much lower eventually (GE was forced to sell shares at a ~20 year low, after huge buybacks at much higher prices).
Fixes
Most importantly, corporations need to institute compensation systems that actually reward executives for long-term success, and remove conflicts like these from the system. Hopefully investors and boards of directors are waking up from their hazes.
Investors also need to start looking beyond PEs and dividends, and into the murky balance-sheets beneath. We’ve ignored corporate balance sheets for too long (i.e. highly-leveraged REIT disasters like GGP). This debt-fueled mentality is pervasive throughout American society. The longer we put off changing our behavior, the more painful it’s going to be.
Just to be clear, I’m not saying IBM is a GE or GGP. But the strategy they’re using is simply not sustainable or efficient. And I think it’s crazy that investors apparently gave them a big thumbs up since the announcement, pushing the stock up 2% Tuesday and another 2% yesterday.
Disclosure: Long Apple, no positions in other stocks mentioned. Balance sheet data is as of 3/31/09.
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This article has 18 comments:
Seems to me that you are comparing apples to oranges here. Just because at GE buybacks cost the company billions without benefiting shareholders much, doesn't mean same is true for IBM. Last but not least it's not the dividends and buybacks that caused GE stock and earnings to collapse, but the fact that it was largely a financial company, cleverly masked behind a diersified industrial conglomerate.
IBM hs more income streams than Apple. IBM rewards shareholders with dividends and buybacks. How does Apple reward it shareholders? What happens after everyone on this planet has an ipod or an iphone:-)
That said, there are lots of things about IBM that impress me. First off, I see dividend increases as an "insider's look" at how company management views its own business for the next 2-3 years. A 10% dividend increase tells me that the company sees clear earnings growth and a sound financial foundation. (Share buybacks sort of signal the same thing, but I wish they would put that money into dividends or into making their financial structure even healthier.)
Second, I agree with the commenters who understand the value of immediate and real dividend returns to shareholders as opposed to the speculative return from a hoped-for stock price increase as in the case of Apple and other non-dividend-payers.
Third, I think IBM has done a fabulous job re-inventing itself over the past decade. It has become a model for a modern computer-services business, while still finding ways to extract great value from its legacy days as a purveyor of bg hardware and software. I love their program just announced to finance buyers in advance of those buyers receiving government stimulus funds--that's very creative.
Debt can be a very useful, and sometimes cheap, instrument to fund OPERATIONAL growth. But to argue that cash should go out as dividends (no impact on operations) or out to purchase stock (no impact on operations) is ridiculous. All this does is remove future financial flexibility. The temporary 'stock price bump' which carries NO benefits to operations is the only accomplishment.
I happen to agree that in many respects, IBM is operationally very well managed. I do not own stock, though, because overall, management is failing shareholders by over-leveraging for foolish purposes.
Oh, one more thing. Why is vendor-financing once again looked at as something innovative and creative? This is the same stupid program that flooded channels in the internet bubble. It isn't innovative. It was a short-term prop for sales in 1999 and it is a short-term prop for sales now.
Regarding the Apple not paying a div, we'll just have to agree to disagree on that one. Eventually they probably should pay out a dividend, but I'm in no rush. I'll take big ol' capital gains in the meantime.
Jason722 - Exactly. It's about fiscal responsibility on every level. I kinda jumbled the message. Was trying to keep preachiness to a minimum.
has shown us is that high levels of debt can cost the company in
many ways, from interest charges, lost profits paying the debt over
many years, the share price, and what companies are doing with
their cash.
MSFT has very little debt, so buy backs are ok. I wish they had bought
more when the price was low.
Thanks for the heads up on IBM, I had no clue the debt levels were
so high. I'm in the same boat as Warren, I like companies
that have lots of cash and little debt. PFE, just spend a ton
of their cash, and went deeper into debt. How that plays out going forward will be interesting.
Another issue with buybacks is that they are used mostly to cover for stock options issued to executives. I remember Cisco Systems buying back 10 billion in stock a few years ago (I think 2007) that mostly covered stock options that they had issued over the last few eyars. It created no value for stockholders. They wasted 10 billion. Even Larry Kudlow on CNBC was angry.
Because stock buybacks rarely create value for stockholders, I would prefer dividends that go directly to my brokerage account.
www.ibmemployee.com/
But linking layoff to the topic is meaningless.
On Apr 30 07:15 PM desicon wrote:
> I agree stock buyback using borrowed money does not make sense. Particularly
> when they are carrying debt in their books.
>
> But linking layoff to the topic is meaningless.
I like the increasing EPS (16% over past 5 yrs and 10% projected next 5 yrs)
I like the increasing cash flow
Buybacks can be advantageous to shareholders
I like my increased dividends
I like the 45.66 bil Gross Profit compared to the 30 bil debt
IBM is a great buy at 10.5 times current earnings. Debt is something that needs to be managed and all major corporations utilize debt to maximize returns on invested capital.
IBM is well managed and not overburdened with debt. I would prefer a little less debt at this time but I dont know what return opportunities they have for investment alternatives.
Finally revenue did drop in one of the worst business years in my lifetime but not EPS. I think that masks the actual 5 year growth IBM offers. You have to like their Systems and Services business. If you arent paying close attention to IBM it is likely a much different company than what you think it is.
Signed - A contented shareholder
On May 01 09:22 PM jstratt wrote:
> I beg to differ on IBM
>
> I like the increasing EPS (16% over past 5 yrs and 10% projected
> next 5 yrs)
> I like the increasing cash flow
> Buybacks can be advantageous to shareholders
> I like my increased dividends
> I like the 45.66 bil Gross Profit compared to the 30 bil debt
>
> IBM is a great buy at 10.5 times current earnings. Debt is something
> that needs to be managed and all major corporations utilize debt
> to maximize returns on invested capital.
>
> IBM is well managed and not overburdened with debt. I would prefer
> a little less debt at this time but I dont know what return opportunities
> they have for investment alternatives.
>
> Finally revenue did drop in one of the worst business years in my
> lifetime but not EPS. I think that masks the actual 5 year growth
> IBM offers. You have to like their Systems and Services business.
> If you arent paying close attention to IBM it is likely a much different
> company than what you think it is.
>
> Signed - A contented shareholder
>