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.
