IBM just announced a $3b share-buyback and 10% increase to their dividend, despite a 10% decrease in Q1 revenue. Judging by moves like this, the concept of deleveraging has not caught on at many big companies. So it looks like financial wizardry will be with us for a while longer.
Using Debt to fund Buybacks and Dividends
It was just last October that IBM raised $4 billion from bond sales. The money wasn’t cheap, either. Yields ranged from 6.5% for the 5 year bond, to 8% for the 30 year bond (details here). And now they announce a $3 billion share repurchase, and a div boost?
Official numbers are hard to find, but it looks like IBM has laid off up to 10,000 North American workers so far this year. Public companies like IBM 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 can’t be good 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“. 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 JUDDBSBLLSSRSTPOSYWHBLSPPOFBWWATL.
Focused on the short-term
So, will the buybacks, layoffs, and dividends that IBM purchased be worth the cost? Highly unlikely. They may succeed in temporarily juicing the stock price, which is what management probably wants to happen. That will allow for bonuses and profitable options. But will these moves be good for IBM 10 years down the road? No.
Sketchy moves like this buyback should discourage investors from buying IBM. Wall St, however, was impressed with IBM’s flexing. The logic must have been along these lines, “yield good, money good, earnings good. buy ibm.” I don’t get it, there are a just so many better companies to own than IBM. Among other tech companies, I’d take 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. 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, which 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 pretty bad too.
GE is arguably the worst offender when it comes to this type of scheme. In their day, GE made IBM’s announcement today look miniscule. From 1994 to 2004, GE bought back 1.1 billion of their own shares, at a huge premium to their price today. 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 it’s a staggering amount. This year alone, they were on track to pay out ~$13b in dividends, until they had to reluctantly slash the payout.
Paying the tab
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.
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 today 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 gives IBM a Current Ratio of 1.18x, meaning their short-term liquidity situation isn’t great. In our current economic environment, why are they scraping by with minimal liquidity, while 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’ll keep re-financing and rolling debt over for eternity. Who knows, they might be forced to sell back those repurchased shares eventually (GE was forced to sell shares at a ~20 year low).
We are in serious need of a compensation system that actually rewards executives for long-term success, and removes conflicts like these from the system. I heard Lloyd Blankfein, Goldman’s CEO, on NPR the other day comparing executives like himself to pro-basketball players, “They get paid a lot too, we’re all just really awesome at our jobs” was essentially what he said. Is he serious?!?! First of all, I don’t recall the last time taxpayers bailed out failed NBA teams. And while Goldman may have avoided much of the damage from this collapse, they created more than their fair share, in my opinion. See this post for more on that topic…
Investors and analysts need to start looking beyond PEs and dividends, and into the murky balance-sheets beneath. We’ve glossed over corporate balance sheets for too long (ie highly-leveraged REITS like GGP). This debt-mentality is pervasive throughout American society. And 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 today, pushing the stock up 2% on a down day.
Disclosure: Long Apple, no positions in other stocks mentioned.
Balance sheet data is as of 3/31/09, pulled from Etrade.