When chickens come home to roost, IBM ...
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WHAT BUSINESS IS IBM IN, INFORMATION TECHNOLOGY OR COMMON STOCK MANAGEMENT? WHEN CHICKENS COME HOME, IBM WORTH NO MORE THAN $20 PER SHARE.
Our current inclination is to doubt that last week's bubble of corporate buying to a combined $5+ billion (2/3 new + 1/3 completed cash takers + new buyback announcements) will continue. Over 60% was due to an IBM buyback. We publicly had been doubting that corporate America will keep borrowing to buy back shares.
Then IBM last week announced a $3.5 billion buyback plus an increase in the cash dividend to 15¢ from 14¢. So we decided to take a look at IBM to see why they were announcing a big buyback and a dividend hike. What we found out is that IBM is operating as if its main business is supporting its share price, not Information Technology.
According to IBM's 1Q 2002 press release and 2001 10K, IBM has bought back $1.8 billion of its shares during the 1Q of this year. Contrast that 1Q 2002 big buyback with just $1.7 billion in pre-tax earnings and a massive 12% drop in 1Q revenues. IBM's 1Q 2002 stock repurchase was about half the $3.7 billion IBM spent during 2001, which was down from $6.1 billion in 2000 and $6.6 billion in 1999.
IBM BOUGHT BACK $1.8 BILLION DURING 1Q OF 2002 VS. $3.7 BILLION DURING ALL OF 2001.
Why would IBM buy back during the 1Q of this year an amount equal to half of the entire amount bought back last year? Could the plunge in IBM's stock from over 120 at year end 2001 to 82 on Friday have anything to do with the amount of shares bought back, particularly when employee options are 10.4% the outstanding?
IBM has 1.717 billion shares outstanding. The 10K says while total options out are 178 million, at year end 2001 there were 35 million options out with an average price of 28 and 38 million options with an average price of 63. At a market price of 120 the employees owning those 73 million options had a profit of over $5 billion.
That is more than the market value of most of the stocks that currently trade on the NASDAQ! However, at 82, the in the money value of those 73 million options is down 50% to $2.6 billion. Poor babies!
IN-THE-MONEY VALUE OF IBM OPTIONS DROPPED 50% FROM $5 BILLION TO $2.6 BILLION.
No wonder IBM management is willing to do whatever is possible to hold up the stock price. Including buying back $1.8 billion in stock. And all this is happening while cash flow is looking horrible.
Cash flow data for the 1Q of 2002 was unavailable this past weekend when we wrote this. However, since earnings and revenues were down in the 1Q of this year, looking at all of last year's results in the 2001 10K leaves us worried. The 2001 10K shows that IBM generated $12 billion in cash from after tax earnings plus non-cash charges.
After capital expenditures of $6 billion, IBM had free cash flow of $6 billion. However, in addition to spending $3.7 billion for buybacks, IBM also paid out $1 billion in dividends and had to repay $8 billion in other debt. In other words, IBM had to borrow to not only buyback shares but repay older debt.
CASH PLUNGES $2.4 BILLION IN 1Q 2002 TO PAY FOR BUYBACKS.
The 10K indicates that as of year end 2001 IBM had $5.4 billion of long term debt that matures in 2002 plus $4.8 billion of commercial paper outstanding. Given all that horrible financial reality, how did IBM fund its 1Q 2002 aggressive buyback? During the 1Q of 2002, cash on IBM's balance sheet plunged $2.4 billion from $6.4 billion to $4 billion. That $4 billion can't support all of IBM's financial needs for the rest of this year.
IBM's cash flow is not likely to rise anytime soon. In this new age of creditor vigilante activism, will IBM's creditors keep on lending to not only repay maturing debt but fund new stock buybacks so that insiders can support the declining value of their options? Perhaps a more important question is how much is IBM worth?
ASSUMING FREE CASH FLOW OF $3 BILLION - IN GOOD YEAR - IBM WORTH $40 BILLION, OR $20 PER SHARE.
The top line, revenues, have been dropping steadily, from $87.5 billion in 1999 to $85.9 billion in 2001 to who knows how much less this year. At current prices IBM has a market cap of close to $145 billion. Total debt of $24 billion is only partially offset by $4 billion in cash.
To be generous, let's use last year $6 billion of free cash flow and assume that's a base number going forward - even though we know it will lots less this year. From that $6 billion subtract, say, $2 billion for debt amortization and $1 billion for dividends. That leaves $3 billion. Is that $3 billion worth much more than 10 times? We doubt it.
However, let's value that at 13 times. Therefore, in our opinion IBM is worth no more than $20 per share. And all that does not even include any of the nonsense imbedded in the IBM pension fund expected rate of return or in reality rate of negative return. |
