IBM: A Huge Debt Load

| About: International Business (IBM)

Summary

IBM has $46.47 billion of debt on the books as of June 30, 2014.

About $18 billion of that debt matures during 2015-2018, a period that can be expected to see higher interest rates.

I will discuss how well IBM is situated to deal with higher interest rates.

International Business Machines (NYSE:IBM) has a total of $46.47 billion in short-term and long-term debt on the books as of June 30, 2014.

In the last few years, the debt issuance can be largely correlated with IBM's massive buyback program:

Click to enlarge

(source: advisorperspectives.com)

The direct results of the program are easy to see as the outstanding shares have dropped by about 25% over the last five years:

IBM Shares Outstanding Chart

IBM Shares Outstanding data by YCharts

Naturally, using debt to buy shares results in a rising debt to equity ratio. Below is a chart of that ratio over the last five years:

IBM Debt to Equity Ratio (Quarterly) Chart

IBM Debt to Equity Ratio (Quarterly) data by YCharts

That looks like a scary trend! Or is it?

First, I will look at the short term and focus on interest payments vs. cash flow. The assumption is that today's low interest environment coupled with IBM's excellent credit rating (recently upped from A+ to AA- by S&P) provides conditions in which rolling the debt essentially keeps things humming along as is. Second, I will discuss the long-term implications of rolling the debt in an environment in which rates are likely to be higher.

The Short-Term Outlook

In the short term, IBM's debt costs the company about $1 billion per year. Note that the figures below are for the first six months of the year.

Click to enlarge

(source: June 30, 2014 10-Q filing)

The chart below shows IBM's net income and cash from operations for the last five years:

IBM Net Income (<a href=

IBM Net Income (TTM) data by YCharts

IBM's cost of debt amounted to 8.0% of the company's net earnings in the first six months of 2014. By comparison, dividend payments amounted to 32.0% of earnings in the first six months of 2014.

In the short-term IBM clearly has no problem paying for its debt.

The Long-Term Outlook

It is impossible to predict IBM's exact schedule of rolling debt and the interest rates that will be paid, particularly for debt that will not mature for many years. However we can make some estimations for a large chunk of debt that will need to be addressed in 2015-2018.

We can see below that the company has about $18 billion maturing in 2015-2018.

Click to enlarge

(source: June 30, 2014 10-Q filing)

For the debt that will mature in that four-year time span, I will calculate the additional cost that a 100 basis point rise in rates would have on IBM's debt payments. Easy enough:

  • $18 billion x .01 = $180 million per year

We also need to compute the additional cost that a rise in rates would incur on IBM's short-term debt. Note that in the figures below, "current maturities" needs to be subtracted out because it was included in the long-term debt figures above.

Click to enlarge

(source: June 30, 2014 10-Q filing)

Therefore, the amount of short-term debt to look at is about $7 billion as of two months ago. Assuming a constant $7 billion in commercial paper (this figure is highly volatile) and an increase of 100 basis points in the rate, then the effect of such an increase would be:

  • $7 billion x .01 = $70 million per year

Therefore, in total we can see that IBM's annual cost of debt would rise from $1 billion to about $1.25 billion by the year 2018 if a 100 basis point rise occurred. A 200 basis point rise would result in about $1.5 billion of annual payments.

Conclusion

Total debt of over $45 billion seems like a lot. If rates were to spike up a substantial amount very quickly, then IBM's bottom line could suffer enough so that we would see a noticeable effect on the stock price. However, I have shown that if the short-term debt and the amount of the long-term debt that matures within the next four years averages a 200 basis point rise, then the cost of the debt only shaves a few percentage points off of IBM's earnings.

In addition, it is worth noting that IBM could pay off the majority of its debt in only two years. Although the company's stock has languished recently due to a lack of revenue growth, this is still a company that makes an enormous amount of money. If we were discussing a company losing money or, say, the US Government, we might wonder how those entities could ever pay off such a large sum of money. IBM could actually pay off debt rather quickly if it needed to.

In my opinion, IBM is doing a good job of taking advantage of low interest rates. Although it is debatable whether or not buying back stock was the best use of those funds (perhaps $35 billion of acquisitions since 2012 would have been more fruitful, for example), I think in the long run we will see that it was a smart move for the company. Perhaps not the optimal move, but a smart move nonetheless.

As long as rates do not shoot up too high - which in the next few years would be shocking - IBM's debt is easily manageable. Over the very long term the debt certainly bears watching, but I consider it something for the back burner for now.

Disclosure: The author is long IBM.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.