Is IBM's CEO Overpaid?

| About: International Business (IBM)

Summary

How does Rometty's compensation compare to other tech CEOs ?

Did Rometty influence IBM's results in a positive way?

Is her compensation justified?

IBM's (NYSE:IBM) shareholders have faced a rough time over the last years, yet this year IBM's CEO Rometty got a multi-million bonuses. I've read a lot of comments stating this was unjustified, including here on Seeking Alpha. In this article I'll try to examine whether her compensation is indeed unjustified.

Virginia Rometty, IBM's CEO, got a $4.5 million bonus for 2015, in addition to $1.6 million in base salary. In addition Rometty got $13.3 million in stock awards, those will be paid out in three years (early 2019). Rometty thus gets total compensation of $19.4 million for 2015, which is an eight percent increase over 2014's total compensation of $17.9 million. Rometty's bonus of $4.5 million was below the company's target of $5.0 million for 2015, which means IBM did not pay out the full bonus this year -- it seems Rometty's results were not as good as they would have to be for her to get the full bonus.

IBM produced $13.1 billion in free cash flows in 2015 (up 0.7 billion over the prior year), and paid out $19.4 million to its CEO Rometty. Since we can interpret free cash flows as the payments the company's shareholders get (through dividends and share repurchases), we get to a ratio of 675:1 for shareholder payments to CEO compensation.

Let's look at this metric for related tech companies, all with a market capitalization of $120 to $150 billion:

Company FCF CEO compensation Ratio
Intel $10.2 billion $11.2 million 910:1
Cisco $11.6 billion $16.8 million 690:1
Oracle $11.3 billion $64.0 million 177:1
Peer group $33.1 billion $92 million 360:1
IBM $13.1 billion $19.4 million 675:1
Click to enlarge

After comparing these three peer companies to IBM, we get to the conclusion that Rometty's payments are below the peer group average. For every $675 generated for the company's owners, Rometty gets $1 in annual compensation, whereas the peer group CEOs get one dollar for every $360 generated for the respective company's owners.

We can also look at other metrics:

Company Revenue CEO compensation Ratio
Oracle $37 billion $64.0 million 580:1
Intel $55 billion $11.2 million 4910:1
Cisco $50 billion $16.8 million 2980:1
Peer group $142 billion $92.0 million 1540:1
IBM $82 billion $19.4 million 4230:1
Click to enlarge

IBM has the second lowest revenue to CEO payment ratio, and its CEO payment relative to the company's revenues is less than half of the peer group average.

Company Operating income CEO compensation Ratio
Oracle $13.0 billion $64.0 million 203:1
Intel $14.0 billion $11.2 million 1250:1
Cisco $12.2 billion $16.8 million 726:1
Peer Group $39.2 billion $92.0 million 426:1
IBM $15.0 billion $19.4 million 773:1
Click to enlarge

When we look at what portion of each company's operating income is paid to the company's CEO, we see that Rometty's compensation is lower than the average peer group compensation. Rometty's compensation (relative to the company's operating income) is the second lowest after Krzanich's (Intel) compensation.

One could argue about CEO compensation being too high in general, but relative to the peer group Rometty's compensation is rather low, she is not overpaid at all.

Rometty (and any other CEO) has some influence on some metrics of the company they lead, but some numbers are out of a CEO's reach. Let's look at some of them and how Rometty did there:

Revenues: In 2015 IBM's revenues declined one percent (when adjusting for currency rates and divestitures), which isn't a good result per se, but which is not too bad either. Keeping (adjusted) revenues relatively flat is something a lot of companies do, the average for all S&P 500 companies saw sales decline as well (-1.6 percent). When we look per share metrics -- which better reflects the effect of a shrinking share count -- we see that (adjusted) revenues per share are up 1.7 percent over the prior year. As an example: The revenues (theoretically) belonging to a 100 share investment in IBM grew from $8170 to $8340 over the last year. This is not a great result, but not bad either, I believe.

Earnings: In 2015 IBM's adjusted net income totaled $14.7 billion, which is a twelve percent decline yoy. 2014's results included one time gains from divestitures though, when we adjust for that net income is down five percent over the prior year's quarter. Earnings per share declined three percent yoy, reflecting the effects of a lower share count. I don't think this result is good, even adjusting for currency and one time gains in 2014 IBM's earnings are down. I can live with revenue decreases as long as earnings go up, but seeing earnings decline doesn't cast a positive light on IBM's leadership.

Free cash flows: This, I believe, is the most important number for investors. Free cash flows allow for direct payments towards shareholders via dividends, share repurchases and allow a company to buy in additional growth (by using parts of FCF for acquisitions). In 2015 free cash flows grew six percent to $13.1 billion, which, I believe, is a good result. The company's free cash flow to revenue ratio keeps increasing, and with growing cash flows the company is able to keep shareholder returns high -- ample dividend growth and share repurchases are possible as long as IBM manages to grow free cash flows. Free cash flow per share hit $13.33, which is a new all time high for the company (and an eight percent increase yoy) -- a strong result indeed.

We can summarize that IBM's management was able to grow revenues per share very slightly (which is a small positive), whilst earnings per share decreased (which is a negative) and free cash flow per share hit a new all time high (which is a huge positive). All in all IBM's performance (regarding these three metrics) was not bad, and I can live with a compensation increase for Rometty.

In fact, Rometty's annual compensation growth rate (eight percent) is exactly as high as IBM's free cash flow per share growth rate (eight percent), which reflects the theoretical compensation for the company's owners.

There is one metric investors will be very unhappy with for the prior year (and the years before that), which is the performance of their shares. IBM's shares are down about forty percent from the company's all time high around $210, and those who bought back then will be very unsatisfied with their returns. Unfortunately Rometty does not control the price the market is willing to pay for IBM's shares, she only has some power to influence the company's results regarding revenues, earnings, margins, cash flows etc. Blaming Rometty for the almost twenty percent share price decline we have seen over the last year is not justified, since the price of each share is determined by market forces, not the company's CEO.

Takeaway

IBM's CEO Rometty got an eight percent compensation increase in 2015, but her compensation is rather low relative to the peer group average.

IBM did not do bad fundamentally, and since shareholders saw record free cash flows a compensation increase for IBM's CEO seems fair to me.

Shareholders are misdirecting their anger when they blame Rometty for her compensation, IBM's CEO is not doing a bad job and deserves what she earns. The company's share price is not under her control, so blaming her for share price declines is unjustified.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.